Big Picture
Week 4-5: Unit Learning Outcomes (ULO): At the end of the unit, you are expected to
e. To understand fundamental stock analysis and learn to compute the necessary
ratios that are involved in this topic;
f. To understand further what money market is and how it operates, and dig down
deeper to how prices of money market instruments and rates are computed;
g. To know more concepts on bond markets and how it operates;
Big Picture in Focus:
ULOe. To understand fundamental stock analysis and learn to compute the
necessary ratios that are involved in this topic
Metalanguage
To further our knowledge about stock markets, we have to learn how to
recognize when is a stock a healthy one or not from some quantitative items in the
financial statements, and the qualitative characteristics of a company. In this topic,
we will focus on the fundamental analysis, a stock valuation, where we will
determine a stock’s “fair market value.” Along the way, we will come across with the
following:
 Intrinsic Value – a measurement of an asset, e.g. shares and bonds,
worth
 Technical analysis – another type of stock market analysis that
mainly evaluates the price of the stocks through the trends and
patterns of the charts or the price changes in the market
 EIC – Economy, Industry, and Company, a valuation philosophy
 Value investors – investors that believe that purchasing securities
should be justified by the overall economy and the issuing firm
 Growth investors – investors that focus on long-term growth of
company and invest in companies that are performing well despite the
price of shares during the time of purchase
 Stock analysis ratios – ratios which are involved in the analysis of
the stocks
Essential Knowledge
Fundamental analysts focus on measuring the intrinsic value of stocks. In
fundamental analysis, they evaluate the price of a stock and do forecasts through
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examining different factors relating to a company, inter or intracompany factors, e.g.
global financial markets, country’s political conditions, company financial statements, etc.
They study macro and micro economic factors, and qualitative and quantitative factors
that impact a price of a share.
The following are the valuation philosophies under fundamental analysis:
 Investors are almost always risk averse or reluctant to take risks.
 Time value of money is one of its basic principles.
 Cash flows are helpful in predicting future company’s earning.
 Tax affects valuation process.
Fundamental analysts use EIC or Economy, Industry, and Company analysis
wherein they first consider the condition of the overall (1) economy. Whether it is booming
or in recession, and they consider the market risks. The global economy like export and
import, exchange rates, and even the domestic economy which involves the deflation
rate, budget surplus or deficit, employment rate, etc. Then they consider which of the two
(2) industries is most attractive in the period. It is difficult for a firm to do well if the industry
is in distress.
Look!
Illustration source: http://www.bsp.gov.ph/downloads/Publications/2020/BES_1qtr2020.pdf
The construction sector or industry, as of the latest data (Q1 of 2020), has the highest index and this
PREFERRED
STOCK
means
investing in this
sector is reasonable as it has the best performance compared to other sectors.
And after analyzing the industry, analysts look at the (3) company’s health. They
check how risky a business is and analyze its sales sensitivity, operating leverage,
financial leverage through its quantitative and qualitative characteristics.
One of the factors that analysts look at is industry life cycle of companies. This
is the progress of a business through four (4) stages that are common to most businesses.
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It starts with embryonic or introduction, then growth/build-up/consolidation, maturity, and
decline. One shall make sure that, as decline phase is happening to a company that a
fundamental analyst invested in, that company has ways to cope with the pressure of the
industry. Companies must have concrete plans and use their competitive advantages to
manage possible losses from decline.
These fundamental analysts are called value investors as they look at
macroeconomic information, industry news, and the business itself to justify the purchase.
In addition, these factors outside the company’s control are:
 Industry and its growth – as stated above, the overall performance of a
specific sector, e.g. mining and oil, services, finance, etc. It is better to invest
in a growing industry
 Customer – the behavior of customers towards a product which may be
affected by preference
 Market share – the percentage of the total sales a company has over other all
companies within a specific market, say for example, Marco Polo’s percentage
sales over all the hotels in the Philippines
 Competition – rivalry of companies that affects their sales. One should look
for a company that already earned its name or one that has huge potential to
grow and build name
 Regulations – rules and laws set by the authority, usually by the government
These are also factors that a company can control:
 Intangibles of a company – assets that are not physical in nature say brand
name, copywrites and trademarks that a company built up
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





Business model – design of a company’s operations and strategy that leads
to its success
Competitive advantage – attribute that makes a company better than its
competitors. This can be earned through good management.
Management – how the executives grow its company using a business model
Corporate Governance – compared to management, this is more on how the
executives protect the company and its reputation
Transparency – deals with honesty and openness about the company and its
operations. Say, whenever problems arise, this should not be sugarcoated and
be reported to come up with solution
Structure of the Board of Directors – board of directors are important
element of a company as it links the shareholders and the managers for
decision making
Compared to Value investors, Growth investors pursue steadily growing
companies that have overcome decline stage. They do not really consider the purchase
price that much, as long as the performance of such shares is above average. They focus
more on capital appreciation.
Having been able to discuss the qualitative factors above, we may proceed to the
quantitative factors which is the analysis of financial statement. At this point in time, we
shall focus on the ratios that is related to buying securities. And later on, other ratios will
be tackled in the next sections.
RATIOS
Earnings Per Share (EPS)
This gives us the amount on how much profit is allocated to each
outstanding share of common stock and measures the profitability of a
company. The higher the EPS, the better.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑠ℎ𝑎𝑟𝑒𝑠 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐸𝑃𝑆 =
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠
Price-Earnings Ratio (P/E Ratio)
This is about the relationship between an entity’s share price and
earnings per share and tells us the how a company is performing.
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒
𝑃/𝐸 𝑅𝑎𝑡𝑖𝑜 =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
Book Value Per Share (BPS)
Through this ratio, we can determine how much equity is available to
stockholders (common BPS or preferred BPS).
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
𝐵𝑃𝑆 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑠ℎ𝑎𝑟𝑒𝑠
Price-to-book value ratio (P/B Ratio)
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PB Ratio lets us calculate the value of a firm relative to its book value.
The traditional consideration on good P/B value is less than 1.0 as it is said to
be undervalued. Meaning to say, one may buy the shares below its supposed
equity share.
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒
𝑃/𝐵 𝑅𝑎𝑡𝑖𝑜 =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
Sample problem
The balance sheets of PQR Company at the end of each of the first two years
of operations indicate the following:
2017
2016
Total current assets
₱600,000 ₱560,000
Total property, plant and equipment
960,000
740,000
Total current liabilities
150,000
80,000
Total long-term liabilities
350,000
250,000
Preferred 9% stock, P100 par
100,000
100,000
Common stock, P10 par
600,000
600,000
Paid-in capital in excess of par-common stock
60,000
60,000
Retained earnings
300,000
210,000
The net income is ₱115,000 and interest expense is ₱30,000 for 2017. And
the current market price of the share is ₱22.20 in 2017, and ₱21.25 in 2016.
1. What is the earning per share ratio for 2017?
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑠ℎ𝑎𝑟𝑒𝑠 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐸𝑃𝑆 =
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠
₱115,000 − ₱9,000
𝐸𝑃𝑆 =
60,000 𝑠ℎ𝑎𝑟𝑒𝑠
𝑬𝑷𝑺 = ₱𝟏. 𝟕𝟕
2. Given the EPS above, what is the P/E Ratio PQR’s security in 2017?
₱22.20
𝑃/𝐸 𝑅𝑎𝑡𝑖𝑜 =
₱1.77
𝑷/𝑬 𝑹𝒂𝒕𝒊𝒐 = 𝟏𝟐. 𝟓𝟒
3. Assuming it was made certain that common stock’s share in the equity is
P675,000, net of all deductions, what is the book value per common shares
in 2016?
₱675,000
𝐵𝑃𝑆 =
60,000 𝑠ℎ𝑎𝑟𝑒𝑠
𝑩𝑷𝑺 = ₱𝟏𝟏. 𝟐𝟓
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Sample problem (cont.)
4. With reference to #4, what is the P/B Ratio?
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒
𝑃/𝐵 𝑅𝑎𝑡𝑖𝑜 =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
₱21.25
𝑃/𝐵 𝑅𝑎𝑡𝑖𝑜 =
₱11.25
𝑷/𝑩 𝑹𝒂𝒕𝒊𝒐 = 𝟏. 𝟖𝟗
In the problem above, if the industry average EPS for 2017 is ₱1.50, we may say
that the share is a good buy as it is higher than industry average. However, the P/E ratio
in 2017 is 12.54 meaning to say, the share is overvalued 12.54 times. Investors are willing
to pay 12.54 times its price. In addition, the book value per share tells us that, should the
company dissolve, each share has ₱11.25 in 2016. And lastly, we may interpret P/B ratio
in 2016 this way. It depends upon the characteristic of an investor. By tradition, if P/B ratio
is less than 1.0, this means the stock is potentially undervalued. But for value investors,
they consider 3.0 as their ceiling therefore, PQR may be a good business for them.
We may also look at the ROE of a company, or the Return on Equity. This ratio
shows how much an entity has changed or increased its earnings. The higher the ROE,
the more efficient a company is.
Return on Equity
𝑅𝑂𝐸 =
or 𝑅𝑂𝐸 =
To continue the problem above, PQR company, we may say that the ROE for
2017 is 10.85%. That is:
₱115,000
𝑅𝑂𝐸 =
₱100,000 + ₱600,000 + ₱60,000 + ₱300,00
𝑅𝑂𝐸 =
₱115,000
₱1,060,000
𝑹𝑶𝑬 = 𝟎. 𝟏𝟎𝟖𝟓 𝐨𝐫 𝟏𝟎. 𝟖𝟓%
We have noted that the computations above are only our guide and will not
necessarily immensely lessen the risk on investment as investment is risky in its entirety.
Nonetheless, having basis on how and where to invest will narrow down the potential
businesses or corporation that are favorable.
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Let’s Check
Activity 1. Now that you have a grasp of what is Fundamental Analysis is, let us see what you
have understood in this chapter. In each item, kindly choose the letter of the best answer.
1. This type of stock analysis believes that the value of stocks is affected by the business
activities of a company and its economic activities.
A. Stock analysis
B. Fundamental analysis
C. Technical analysis
D. Financial analysis
2. This type of stock analysis focuses more on the movement of chart prices to evaluate value
of securities.
A. Stock analysis
B. Fundamental analysis
C. Technical analysis
D. Financial analysis
3. The following are true regarding EIC analysis, expect
A. EIC analysis means Economy, Industry, and Company.
B. The best way to analyze stocks is through analyzing the company first, then the industry
that it is in, and finally checking the economy.
C. After looking for the best industry, qualitative and quantitative elements of a company is
analyzed.
D. All are true.
4. I. Growth investors seek for steadily growing companies.
II. While value investors believe that securities are of good buy once the underlying EIC
factors are desirable.
A. Statement I is true.
B. Statement II is true.
C. Statements I and II are true.
D. Statements I and II are false.
5. I. Management and corporate governance has the same objectives.
II. Intangibles of a company involves nonphysical assets such as trademarks, property plan
and equipment, and copy rights.
A. Statement I is true.
B. Statement II is true.
C. Statements I and II are true.
D. Statements I and II are false.
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6. The following are the valuation philosophies under fundamental analysis, except:
A. Investors almost always non-risk takers.
B. Tax affects valuation process.
C. Cash flows are helpful in predicting past company’s earning.
D. Time value of money is one of the principles it applies.
7. The price/earnings ratio
A. measures the past earning ability of the firm.
B. is a gauge of future earning power as seen by investors.
C. relates price to dividends.
D. relates to the price of the security.
8. ROE
A. means return on equality.
B. is net income over net assets.
C. is BPS over EPS
D. helps one to know the liquidity of a company and its performance.
9. Which of the following is/are true?
A. The higher the EPS of a company, the better.
B. Investors generally prefer P/E Ratio which are below 3.0.
C. Book value per share dictates how much income is attributable to one share.
D. P/E ratio is Net income divided by market price.
10. This ratio will guide us in checking whether the price of a share is overvalued or undervalued
by comparing the EPS and the market price.
A. Price to book ratio
B. Earnings per share
C. Market value
D. Price-earnings ratio
Let’s Analyze
Activity 2. In addition to the problems above, let us apply what we have learned to these
problems below. Kindly show your solutions as you answer.
1. On December 31, 2016 and 2017, Rose Group of Companies had 200,000 shares of
common stock and 40,000 shares of noncumulative and nonconvertible preferred
stock issued and outstanding.
Additional information:
Stockholders’ equity at 12/31/17
₱4,000,000
Net income year ended 12/31/17
1,500,000
Dividends on preferred stock year ended 12/31/17
400,000
Market price per share of common stock at 12/31/17
₱ 144.00
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The P/E ratio on common stock at December 31, 2017, was
2. Daffodils Corporation’s stockholders’ equity at December 31, 2018 consists of the
following:
6% cumulative preferred stock, P100 par, liquidating value
was P110 per share; issued and outstanding 5,000 shares ₱500,000
Common stock, par, P5 per share; issued and
outstanding, 400,000 shares
200,000
Retained earnings
100,000
Total
₱800,000
Dividends on preferred stock have been paid through 2017.
On December 31, 2018, Daffodils Corporation’s book value per share was
3. The current annual sales of Amethyst, Inc. are ₱180,000. Sales are expected to
increase by 5% next year. The company has a net profit margin of 6.5% which is
expected to remain constant for the next couple of years. There are 12,000 common
stock outstanding. The market multiple is 16.4 and the relative P/E of the firm is 1.31.
What is the expected market price per share of common stock for next year?
4. A company’s total common shares are valued at ₱600,000 and had a par value of ₱10.
If net income is ₱115,000 and interest expense is ₱30,000 for 2020 and the company
had declared ₱12,000 preferred dividends, and the market price is ₱30, What is the
price-earnings ratio on common stock for 2020.
5. What is Marigold Company's net income given the following?
Total assets = $250,000
Total Liabilities = 25,000
Revenue = $30,000
ROE = 12%
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In a Nutshell
Now that you have had necessary basics for stock trading, let us see what we have learned in this
chapter.
1. There are two types of stock analysis that were mentioned in this section. Those are fundamental
analysis and technical analysis
2. In doing fundamental analysis, one should consider the economic conditions of a company and
later on narrow down one’s analysis to company level through several quantitative and qualitative
factors.
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Self-Help: You can also refer to the sources below to help you further
understand the lesson:
Brigham, Eugene & Houston, Joel F. (2015). Fundamentals of Financial Management
(13th Edition). Pasig City: Cengage Learning Asia Pte Ltd (Philippine Branch),
[2014] [2015].
Wang, Yun-Chin, et al. “Does Fundamental and Technical Analysis Reduce Investment
Risk for Growth Stock? An Analysis of Taiwan Stock Market.” International
Business Research, vol. 7, no. 11, 2014, doi:10.5539/ibr.v7n11p24.
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Big Picture in Focus:
ULO f. To understand further what money market is and how it operates,
and dig down deeper to how prices of money market instruments and
rates are computed
Metalanguage
We have several kinds of instruments, but there is only one topic for short-term
investments and that is money market. Its basics, that are vital to your understanding in
finance, management, and even financial accounting, will be tackled in this section.
These are several terms that we have to know in advance:
 Money markets – market where instruments sold mature in less than a year,
usually sold in large denomination size. Money market instruments are
characterized by low liquidity risk and low default risk.
 Bond equivalent yield – the rate used to calculate the present value of
money market instruments, but does not consider the effects of
compounding.
 Effective annual return – the true annual rate earned when interest is paid
more than once in a year or compounded.
 Discount yields – return received for having been able to buy bonds at a
discount as a result of pre-deducted interest income
These shall all be discussed further as we go along with the discussion.
Essential Knowledge
Money markets sell short-term debt instruments to keep a government’s or
corporation’s cash flow steady. This market that does not have a particular geographic
location, and the instruments sold here are in large denominations sizes like treasury bills
from the Bureau of Treasury. (Illustration on the next page.)
Money market instruments
Treasury bills – short-term instruments issued by the government.
This instrument is said to be zero-risk security.
Federal funds – short-term funds transferred between two financial
institutions for no more than one day.
Repurchase agreements – contract that involves sale of securities by
one party to another with a promise to repurchase the same at a
specified date and price.
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Money market instruments
Commercial paper – short-term unsecured promissory notes issued by
large and prominent companies to raise short-term cash
Negotiable certificates of deposit – a bank-issued time deposit that
specifies an interest rate and maturity date and is negotiable
(saleable on a secondary market)
Banker’s acceptance – time drafts payable to a seller of goods, with
payment guaranteed by a bank
Source: https://www.treasury.gov.ph/wp-content/uploads/2020/09/Treasury-Bills-Public-Offering-on-07-SEPTEMBER-2020-.pdf
Treasury bills are sold through auction. In the Philippines, the auction date is every
Monday and/or Tuesday for 35-day, 91-day, 182-day, and 364-day treasury bills. And the
cut-off time 1:00pm. Bid price is the amount the dealers are willing to pay the T-bills
holder to purchase their T-Bills. While ask price is the price set by the dealers that is
available to the investor. These prices are usually set at a discount, which will lead to our
next topic, calculating the price and returns of treasury bills.
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BOND EQUIVALENT YIELD and DISCOUNT YIELD
In addition to the details discussed in the essential knowledge, this gives the
quoted nominal interest rate in a year.
𝑖
=
×
and
𝑖
=
×
where
Pf = Face value
P0 = Purchase price of the security
h = Number of days until maturity
Sample problem
The Republic of the Philippines issued ₱100,000 T-Bill that can be bought for
99. This T-Bill will mature 90 days. Compute for the bond equivalent yield
and the discount yield.
Bond equivalent yield
𝑃 − 𝑃
365
×
𝑃
ℎ
₱100,000 − ₱100,000(0.99)
365
=
×
₱100,000(0.99)
90
𝒊𝒃𝒆𝒚 = 𝟒. 𝟏𝟎%
𝑖
𝑖
=
Discount yield
𝑃 − 𝑃
365
×
𝑃
ℎ
₱100,000 − ₱100,000(0.99)
360
=
×
₱100,000
90
𝒊𝒅𝒚 = 𝟒. 𝟎𝟎%
𝑖
𝑖
=
The formulas above are useful to get the fair value of a security, particularly
money market instrument, through applying these interest rates to these formulas which
either ways, will give us the same answers.
𝑃 = 𝑃 − 𝑖
,
×
and
×𝑃
𝑖
,
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×
𝑃 = 𝑃 ÷ 1+
Sample problem
At a point in time, the asked (discount yield) of a ₱10,000 T-Bill is 0.158%. How
much is the price of this bill if the settlement date is on 77 days?
Discount yield
ℎ
×𝑃
360
77
𝑃 = ₱10,000 − 0.00158 ×
× ₱10,000
360
𝑷𝟎 = 𝟗, 𝟗𝟗𝟔. 𝟔𝟐
𝑃 = 𝑃 − 𝑖
,
×
The asked yield (bond equivalent yield) of the same bill at that same time is
0.160%. Find the price of the bill.
Bond equivalent yield
ℎ
365
77
𝑃 = ₱10,000 ÷ 1 + 0.00160 ×
365
𝑷𝟎 = 𝟗, 𝟗𝟗𝟔. 𝟔𝟐
𝑃 = 𝑃 ÷ 1+ 𝑖
,
×
EFFECTIVE ANNUAL RETURN
In this portion, we shall get the effective annual interest rate of return (EAR) using
the equation below:
Sample problem
Suppose on can invest in a money market instrument that matures in 70 days
that offers 8% nominal annual interest rate, what is the effective annual interest
return on this security?
Effective Annual Return
0.08
365
75
𝐸𝐴𝑅 = 1.0826 − 1
𝑬𝑨𝑹 = 𝟖. 𝟐𝟔%
𝐸𝐴𝑅 = 1 +
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−1
Self-Help: You can also refer to the sources below to help you further
understand the lesson:
𝐸𝐴𝑅 = 1 +
𝑖
365
−1
ℎ
Brigham, Eugene & Houston, Joel F. (2015). Fundamentals of Financial Management
(13th Edition). Pasig City: Cengage Learning Asia Pte Ltd (Philippine Branch),
[2014] [2015].
Fernández, Pablo. “Interest Rates.” Valuation Methods and Shareholder Value Creation,
2002, pp. 133–144., doi:10.1016/b978-012253841-4.50020-2.
Saunders, Anthony, and Marcia Millon. Cornett. Financial Markets and Institutions.
McGraw-Hill/Irwin, 2018.
Let’s Check
Activity 1. In addition to our discussion above, let us check and supplement your knowledge
regarding money markets.
1. Give three common characteristics of money markets.
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2. Kindly cite the difference between discount yield and bond equivalent yield.
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3. What is the difference between repurchase agreement and a reverse repurchase
agreement?
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Let’s Analyze
Activity 2. Let us apply the formula we have above to problems given in this activity.
1. You can purchase a T-bill that is 95 days from maturity for $9,965. The T-bill has a face
value of $10,000.
a. Calculate the T-bill’s quoted yield.
b. Calculate the T-bill’s bond equivalent yield.
c. Calculate the T-bill’s EAR.
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2. Calculate the bond equivalent yield and effective annual return on a jumbo CD that is 115
days from maturity and has a quoted nominal yield of 6.56 percent.
3. You can buy commercial paper of a major U.S. corporation for $495,000. The paper has
a face value of $500,000 and is 45 days from maturity. Calculate the discount yield and
bond equivalent yield on the commercial paper.
In a Nutshell
In this portion, let us check and somehow summarize what we have learned in this chapter.
1. Money market instruments are sold in large denomination sizes
2. There are other methods of computing interest rates and fair value for money market instruments
compared.
YOUR TURN
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6. ___________________________________________________________________________
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Big Picture in Focus:
ULO g. To know more concepts on bond markets and how it operates
Metalanguage
It was mentioned in the previous chapter that we have several types of capital
markets, and one of these is stock market which was already discussed above. Another
type of stock market that we will discuss in this chapter is Bond Market. In this chapter,
we will get acquainted with how it operates and the necessary knowledge we can use in
understanding not just the topic, but other related topics as well. Here are some few
definitions that are vital in understanding the bond markets.
 Bonds – are long-term debt instruments that are issued by both the
government and corporations to raise funds for long-term operations.
 Bond markets – a market where new and existing bonds are traded.
This market generally trades three types of bonds: (1) Treasury notes
and bonds (2) municipal bonds, and (3) corporate bonds.
 Competitive bidding – a process wherein firms/investors who wish to
buy securities submit their competing bids to the issuer who wish to sell
Essential Knowledge
Bond markets sell long-term obligation, called bonds, and transfer funds from
individuals, corporations, and government with excess funds for investment to those who
need funds which are also corporations and government. Bonds that promise to pay
periodic interests and the principal itself on maturity date.
TREASURY BONDS AND NOTES
Treasury bonds and notes are issued by government, say the Philippine treasury,
to fund national expenditures and projects, and the national debt. It is important to note
that just like the treasury bills, government bonds or treasury bonds are also default risk
free as the government will always pay their debts to its investors.
More often, than not, bonds are bought in between interest dates. If this happens,
it means an accrued interest is already existing. The buyer has the responsibility to pay
not just the bond’s purchase price but the accrued interest as well. Purchase price plus
accrue interest is called full price or dirty price. When a price does not include accrued
interest rates, we call it clean price. In the market, prices are quoted in clean price, but
when the sale happens between the buy and the seller, the buyer pays the dirty or full
price.
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The primary market transaction for treasury bonds happens when the Bureau of
Treasury issues bonds, that is every other Tuesday. Below is an example of an offer
from Bureau of Treasury.
Source: https://www.treasury.gov.ph/?p=36842
If one wishes to invest in the primary market of treasury bonds, the Bureau of
Treasury set out these few steps.
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Source: https://www.treasury.gov.ph/rtb/
While most secondary market trading occurs through brokers and dealers such as
BDO, Security Bank, BPI and other banks that offer bonds. One will usually fill up forms
that intends purchase of retail treasury bonds. And once approved by the chosen bank,
the amount will be automatically deducted from the investor’s bank balance.
MUNICIPAL BONDS
Municipal bonds are instruments that are issued by the local government unit or
the state (applicable in USA) with the same reason with the Bureau of Treasury, to
augment temporary shortages in funds. Some opt to buy this type of bonds as this is tax
free which means therefore that transaction cost is lower, therefore return is also lower
compared to corporate bonds.
There are two types of municipal bonds. One is the general obligation bonds, and
the revenue bonds.
 General obligation (GO) bonds – the government promises to pay these
bonds with all their might, including using taxation power to pay such bonds
 Revenue bonds – bonds sold to finance project that are intended to
generate revenue. The revenue generated from these projects will be used
to pay off the bonds issued.
Despite that municipal bonds are issued by a branch of the government that are
not default risk free, it happened in the US during one crisis there.
Just like any other bonds, the trading process for municipal bonds starts with public
offering processed and assisted by investment banks using (1) firm commitment
underwriting. The investment bank guarantees the sale of bonds, buying the whole
issue at a fixed price, and selling the same to the public at a higher price. This purchase
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of shares happens through competitive bidding with other banks or through direct
negotiation with the issuing state or local government.
Another method to sell these bonds is through (2) best-efforts offering where
investment bank does not guarantee the issued shares but only acts as a distributing
agent for a fee. The price of the bonds is lower in this type of sale because selling price
of the bonds is set at the original price.
One may also opt to distribute the bonds through (3) private placement where
banks help the issuing body sell their bonds to large institutions or group of buyers to
purchase the whole issue.
And lastly, we have secondary market trading for municipal bonds, but it is
infrequent because of “lack of information.” People are not well-informed that these
bonds exist plus analyzing such securities is costly.
CORPORATE BONDS
Corporate bonds are debt instruments are issued by corporations. This is backed
up by a legal contract called a bond indenture which contains the covenants of the
bond issued. It contains the rights and obligations of the bond issuer and the bond
holders. This contract lowers the risk of this security.
Characteristics of bonds
Types of ownership
Maturity
Collateral
Bearer bonds – does not record the
information of the bearer(owner) of the bond.
The bond has attached coupon to be paid each
interest period.
Registered bonds – the bondholder’s
identification is kept by the issuer in an
electronic record
Term bond – the entire issue of bond matures
at a single date
Serial bonds – bonds that mature on a series
of dates (not one time), with a portion of the
issue paid off on each of that period
Mortgage bonds – bonds that are issued to
finance specific projects that are pledged as
collateral for the bond issue
Equipment trust certificates – bonds
collateralized with tangible (movable) non-real
estate property
Collateral bonds – bonds collateralized by a
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Claims on asset
Provisions
Other characteristics
financial asset
Debentures – bonds backed solely by the
general credit rating of the issuing firm,
unsecured
Subordinated Debentures – unsecured
debentures that are junior in their rights to
mortgage bonds and regular debentures
Senior debt – first priority to general assets
Sinking fund provisions – the periodic
retirement of a number of bonds
Call provision – gives issuer right to retire
bonds before maturity
Convertible bonds – bonds that can be
converted into common stock
Stock warrants – bonds that give the
bondholder an opportunity to purchase
common stock at a specified price up to a
specified date
Callable bonds – bonds that allow the issuer
to force the bondholder to sell the bond back
to the issuer at a price above the par value (call
price)
Sinking fund provision – bonds that include
a requirement that the issuer retire a certain
amount of the bond issued each year
These bonds are traded public sale or private placement. The process is the same
with how municipal bonds are issued. But unlike corporate bonds, secondary market is
more active for corporate bonds. In the US, NYSE serves as its exchange market called
New York Exchange Bonds Trading Platform, and there are also OTC markets for
bonds.
Bond Ratings
The confidence of investors on whether they will buy a certain bond or not lies on
the bond rating of a company. This serves as a gauge on the riskiness of security
especially default risk. There are independent companies that rank bonds based on
probability of default. In this module, we shall only present two types of ratings in the
table below.
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Those who are risk-averse will choose Aaa or AAA companies while those who
are risk-takers can opt to choose riskier bonds (Baa) as they may earn higher interest
rates. These speculative-grade bonds are called junk bonds.
Self-Help: You can also refer to the sources below to help you further
understand the lesson:
Brigham, Eugene & Houston, Joel F. (2015). Fundamentals of Financial Management
(13th Edition). Pasig City: Cengage Learning Asia Pte Ltd (Philippine Branch),
[2014] [2015].
Choudhry, Moorad. “Review of Bond Market Instruments.” The Bond & Money Markets,
2001, pp. 86–101., doi:10.1016/b978-075064677-2.50008-5.
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Saunders, Anthony, and Marcia Millon. Cornett. Financial Markets and Institutions.
McGraw-Hill/Irwin, 2018.
Let’s Check
Activity 1. Let us see if we understood the topics above through these true-or-false questions.
Answer true if it is true, and if it is false, explain briefly.
1. Capital markets include mortgage markets, foreign exchange markets, money markets
and bond markets.
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2. Bonds are long-term debt obligations issued by the government only.
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3. Aside from maturity value of the bonds, the investor of a bond shall also earn coupon
dividend.
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4. Treasury notes and bonds are issued by the government treasury as well as the
corporations to finance debt and other expenditures.
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5. In computing the present value of the bonds, the interest and the principal shall be
multiplied by present value factor of ordinary annuity.
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6. Municipal bonds have lower interest rate compared to taxable bonds such as corporate
bonds.
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7. Best-efforts offering does not guarantee the price to the issuer and just acts as a
distributing agent only on a fee basis.
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8. A junk bond is a legal contract that specifies the rights and obligations of the bond issuer
and the bondholders.
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9. Sinking fund provisions include a requirement that the issuer retire certain amount of the
bond issue each year.
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10. Debenture bond holders will receive cash distribution only after mortgage bond and
subordinated debenture bond holders have been repaid in full.
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Activity 2. To further our retention on the topics above, let us answer these questions below briefly.
1. Rate the following, mortgage bond, debenture, and subordinate debenture lowest to
highest.
a. Cost to the bond issuer – _________________________________________
b. Risk to the bondholder – _________________________________________
c. Yield to the bondholder – _________________________________________
2. Explain the difference between general obligation bonds and revenue bonds.
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3. Which is more attractive to investors a convertible bond or a non-convertible bond?
Explain why.
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4. Which is more attractive to investors, bonds with call provision or non-callable bond?
Explain why.
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In a Nutshell
In this portion, let us check and somehow summarize what we have learned in this chapter.
1. Bond market is a type of capital market wherein long-term bonds are issued.
2. There is a thing we call bond indenture that underscores the covenants of a certain bond. This
lists all risks and rewards attributable to the issuer and bondholder
YOUR TURN
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KEYWORDS INDEX
This section lists down the keywords that help you to recall the discussions.
ULO e.
Book value per share
Earnings Per Share
Fundamental Analysis
Growth Investor
Industry Life Cycle
Intrinsic Value
Price Earnings Ratio
Price-to-Book Ratio
Return on Equity
Stock Analysis Ratio
Technical Analysis
Value Investor
Discount Yield
Effective Annual Return
Federal Funds
Money market
Negotiable certificates of
deposit
Repurchase agreements
Treasury bills
Competitive bidding
Convertible Bonds
Debentures
Private placement
Registered bonds
Revenue bonds
ULO f.
Ask price
Bid price
Banker’s Acceptance
Bond Equivalent Yield
Commercial paper
ULO g.
Bearer bonds
Best-efforts offering
Bond Indenture
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Bond Market
Bond rating
Bonds
Call Provision
Callable Bonds
Clean price
Collateral bonds
Dirty Price / Full Price
Equipment trust certificates
Firm commitment
underwriting
General Obligation (GO)
Bonds
Junk bonds
Mortgage bonds
Municipal Bonds
Senior debt
Serial Bonds
Sinking fund provisions
Stock warrants
Subordinated Debentures
Term bonds
Treasury bonds and notes
Course Schedule
This section calendars all the activities and exercises, including readings and lectures, as well as time for making assignments
and doing other requirements.
Activity
Orientation
Let’s Check – Items 1-10
Let’s Analyze – Problems A and B
In a Nutshell – Money and Banking
Q&A – Money and Banking
Let’s Check – Items 1-10
Let’s Analyze – Items 1-2
In a Nutshell – Phil. Financial System
and Financial Markets and Institutions
Let’s Check – Items 1-10
Let’s Analyze – Activity 1-3
In a Nutshell – Financial Management
Q&A – Money and Banking
1st Formative Assessment
Date
May 25, 2020
May 29, 2020
June 1, 2020
June 2, 2020
Any day
June 3, 2020
June 4, 2020
Where to Submit
BlackBoard LMS
BlackBoard LMS
BlackBoard LMS
BlackBoard LMS
BlackBoard LMS – Forum
BlackBoard LMS
BlackBoard LMS
June 5, 2020
BlackBoard LMS
June 8, 2020
June 9, 2020
June 10, 2020
Any day
June 11, 2020
BlackBoard LMS
BlackBoard LMS
BlackBoard LMS
BlackBoard LMS – Forum
BlackBoard LMS
Online Code of Conduct
1.
2.
3.
4.
Students are expected to abide by and honor code of conduct, and thus, everyone and all
are exhorted to exercise self-management and self-regulation.
All students are guided by professional conduct as learners in attending On-Line Blended
Delivery (OBD) course. Any breach and violation shall be dealt with properly under existing
guidelines, specifically in Section 7 (Student Discipline) in the Student Handbook.
Professional conduct refers to the embodiment and exercise of the University’s Core Values,
specifically in the adherence to intellectual honesty and integrity; academic excellence by
giving due diligence in virtual class participation in all lectures and activities, as well as fidelity
in doing and submitting performance tasks and assignments; personal discipline in complying
with all deadlines; and observance of data privacy.
Plagiarism is a serious intellectual crime and shall be dealt with accordingly. The University
shall institute monitoring mechanisms online to detect and penalize plagiarism.
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5.
6.
7.
Students shall independently and honestly take examinations and do assignments unless
collaboration is clearly required or permitted. Students shall not resort to dishonesty to
improve the result of their assessments (e.g. examinations, assignments).
Students shall not allow anyone else to access their personal LMS account. Students shall
not post or share their answers, assignments or examinations to others to further academic
fraudulence online.
By enrolling in OBD course, students agree and abide by all the provisions of the Online Code
of Conduct, as well as all the requirements and protocols in handling online courses.
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