TIME VALUE OF MONEY

Time value of money is the math of finance whereby interest is earned

over time by saving or investing money. Money can grow or increase over
time if we can save (invest) it and earn a return on savings.

 Present Value- an amount or value today of savings or investment

 Future Value – value at a specified time or date in the future of a

savings amount or investment

Future Value= Present Value+ (Present Value x Interest Rate)

Or
Future Value= Present Value x (1 + Interest Rate)

Assume you P1,000 to save or invest and a bank offers to accept your
savings for one year and agrees to pay to you an 8% interest rate in a year.

Future Value = P1,000 + (P1,000 x Interest rate)

= P1,080
Or
Future Value = P1,000 x 1.08
= P1,080

 Simple interest- interest earned only on the investment’s principal

Assume that your P1,000 investment remains on deposit for two years but
that the bank pays only simple interest, which is interest earned only on the
investments’ principal

Future Value= Present Value x [1 + (Interest rate) x (number of periods) ]

Future Value = P1,000 x [1 + (.08 x 2) ]

= P1,000 x 1.16
= P1,160
  Compounding – arithmetic process whereby an initial value increases
or grows at a compound interest rate over time to reach a value in the
future

 Compound Interest – earning interest on interest in addition on

interest in addition to interest on the principal or initial investment

To understand compounding, let’s assume that you leave the investment

with a bank for more than one year. For example, the bank accepts your
P1,000 deposit now, add P80 at the end of the year, retains P1,080 for the
second year and pays you interest at an 8% percent year. The bank returns
your initial deposit plus accumulated interest at the end of the second year.
Hpw much will you receive as a future value?

Future Value= Present Value x [ (1 + Interest Rate) x (1 +Interest rate) ]

Future Value = P1,000 x (1.08) x (1.08)

= P1,000 x 1.1664
= P1,166.4
= P1,166. (rounded)

Thus, for a one-year investment, the return would be P1,080 (P1,000 x

1.08), which is the is the same as the return on a simple-interest investment,
as was previously shown. However, a two-year investment at an 8 percent
compound interest rate will return P1,166.40 compared to P1,160 using an 8
percent simple interest rate.
The compounding concept also can be expressed in equation form as:

FV = PV (1+r )n

Where FV is the future value, PV is the present value, r is the interest

rate, and n is the number of periods in years
For our P1,000 deposit, 8 percent, two-year example, we have:

FV = P 1,000 (1+.08 )2
= P1,000 (1.1164)
= P1,166.40
= P1,166 (rounded)

If we extend the time period to ten years, the P1,000 deposit would grow to:
FV = P 1,000 (1+ 0.08 )10
= P1,000 (2.1589)
= P2,158.90
= P2,159 (rounded)
 Discounting to Determine Present Values

Most financial management decisions involve present values rather

than future values. For example, a financial manager who is considering
purchasing an asset wants to know what the asset is worth now rather than at
the end of some future cash benefits. To determine its value now in time
period zero, we have to discount or reduce the future benefits to their present
values.

Discounting- is the arithmetic process whereby a future value decreases at a

compound interest rate over time to reach a present value

Let’s assume that a bank or other borrower offers to pay you P1,000 at
the end of one year in return for using P1,000 of your money now. If you are
willing to accept a zero rate of return, you might make the investment. Most of
us would not jump at an offer like this. Rather, we would require some return
on our investment. To receive a return of, 8 percent, you would invest less
than P1,000 now. The amount to be invested would be determined by dividing
the P1,000 that is dues at the end of one year by one plus the interest rate of
8 percent. This results in an investment amount of P925.93 (P1,000/1.08).
Alternatively, the P1,000 could have been multiplied by 1/1.08 or .9259 (when
carried to four decimal places) to get P925.90
Let’s now assume that you will not receive the P1,000 for two years
and the compound interest rate is 8 percent. What dollar amount (present
value) would you be willing to invest? In word terms, we have:

Present value= Future value x {[1/ (1+ interest rate)] x [1/(1+interest

rate)]}

For two-year investment example, we get:

Present Value = P1,000 x (1/1.08) x (1 / 1.08)

= P1,000 x (0.9259) x (0.9259)
= P1,000 x 0.8573
= P857.30

Future Value of an Annuity

The previous discussion focuses on cash payments or receipts that

occurred only as a lump sum present and future values. However, many
finance problems involve equal payments or receipts over time, referred to as
annuities. Most specifically, an annuity is a series of equal payments
(receipts) that occur over a number of time periods.
An ordinary annuity exists when the equal payments (receipts) occur
at the end of each time period. For example, suppose you want to invest
P1,000 per year for three years at 8 percent interest rate. However, since you
will not make your first payment until the end of the first year, this will be an
ordinary annuity.
 FVA= PMT {[( 1 + r)^n – 1] / 0.08 }
Where PM is the periodic equal payment, r is the compound interest rate, and
n is the total number of periods.

FVA = P1,000 {[(1 + .08)^ 3] / 0.08}

= P1,000 [(1.2597 – 1) / 0.08]
= P1,000 (3.246)
= P3,246

Present Value of an Annuity

Many present value problems also involve cash flow annuities. Usually
these are ordinary annuities. Let’s assume that we will receive P1,000 per
year beginning one year from now of a period of three years at an 8 percent
compound interest rate. How much would you be willing to pay now for this
stream of future cash flows? Since we are concerned with the value now, this
becomes a present value problem.

PVA= P1,000 {[(1 – (1 + r )^n)] / r }

PVA= P1,000 {[1 – ( 1 +0.08)^3)} / 0.08

= P1,000 [( 1 – 0.7938) / 0.08]
= P1,000 (0.2062 / 0.08)
= P1,000 (2.577)
= P2,577

Future Value of an Annuity Due

In contrast with an ordinary annuity, an annuity due exists when the

equal periodic payments occur at the beginning of each period. Let’s return to
the example used in the “Future Value of an Annuity” section in this chapter.
Recall that the problem involved a three-year annuity, P1,000 annual
payments, and an 8 percent interest rate. However, let’s assume that the first
payment now is made at the beginning of the first year, namely at time zero.
This will allow the first P1,000 payments to earn interest for three years, the
second payment to earn interest for two years, and the third payment to earn
interest for one year.
The calculation process to find the future value of this annuity due
problem can be demonstrated as follows:

FV annuity due = P1,000 (1.08)3 + P1,000 (1.08)^2 + P1,000 (1.08) ^1

= P1,000 (1.260) + P1,000 ( 1.166) + P1,000 (1.080)
= P1,000 (1.260 + 1.166 + 1.080)
= P3,056

Notice that by making the first payment now, the future value of this annuity at
the end of here years will be P3,506. This contrasts with a future of P3,246 if
payments are delayed by one year, as would be the case with an ordinary
annuity.
 Present Value of an Annuity Due

Occasionally, you will have to do present value annuity due problems.

For example, leasing arrangements often require the person leasing
equipment to make the first payment at the time the equipment is delivered.
Let’s illustrate by assuming that lease payments of P1,000 will be made at the
beginning of each year for three years. If the appropriate interest rate is 8
percent, what is the present value of this annuity due leasing problem.
The calculation process to find the present value of this annuity due
problem can be demonstrated, as follows:

PV annuity due = P1,000 [1 / (1.08)^0] + P1,000 [1 / 1.08)^1] + P1,000 [1 /

1.08)^2]
= P1,000 (1.000) + P1,000 (0.926) + P1,000 (0.857)
= P1,000 (2.783)
= P2,783

WHY INVEST?

The answer to the question "Why invest?" is similar to the answer to

"Why go to college?" You hope to enjoy life more because of the learning
you'll gain at college. You will likely face more opportunities for advancement
because of a college degree, and studies have shown that, on average, those
with a college degree earn more in salary and benefits over their working
career. You are investing in yourself now and hope to benefit in the future. So
it is with the use of money. We can do two activities with your funds: spend
them now or save them with plans to spend the money some time in the
future. This trade-off of present spending for a higher level of future spending
is the reason for saving. What you do with the savings to make them increase
over time is investment.

Investment

Investment is the setting aside of funds for a period of time in order to

receive expected future benefits. When we make an investment, we set aside
current funds in the expectation of receiving future funds that will compensate
us for (1) the time the funds are committed, (2) the expected rate of inflation,
and (3) the risk of the investment.' A key word here is expectation. Many
investments contain risks so that the actual future payments may be higher or
lower than expected. Someone may buy shares of common stock, expecting
to earn a positive return, but the value of the shares could fall because of an
overall stock market decline or because investors are not willing to pay such a
high price for the stock.

Reasons for Investing

 Grow your money

Investing your money can allow you to grow it. Most investment
vehicles, such as stocks, certificates of deposit, or bonds, offer
returns on your money over the long term. This return allows
your money to build, creating wealth over time.
 Save for retirement
As you are working, you should be saving money for retirement.
Put your retirement savings into a portfolio of investments, such
as stocks, bonds, mutual funds, real estate, businesses, or
precious metals. Then, at retirement age, you can live off funds
earned from these investments. Based on your personal
tolerance of risk, you may want to consider being riskier at a
younger age with your investments. Greater risk increases your
chances of earning greater wealth. Becoming more conservative
with your investments as you grow older can be wise, especially
as you near retirement age.
 Earn higher returns
In order to grow your money, you need to put it in a place where
it can earn a high rate of return. The higher the rate of return,
the more money you will earn. Investment vehicles tend to offer
the opportunity to earn higher rates of return than savings
accounts. Therefore, if you want the chance to earn a higher
return on your money, you will need to explore investing your
money.

 Reach financial goals

Investing can help you reach big financial goals. If your money is
earning a higher rate of return than a savings account, you will
be earning more money both over the long term and within a
faster period. This return on your investments can be used
toward major financial goals, such as buying a home, buying a
car, starting your own business, or putting your children through
college.
Introduction

A person with an acumen for business knows that ability to raise

capital is an important factor when starting a business and in fact even in rug
a business. Therefore, analyzing the nature of debt as against equity and
being clear as to what kind of money is right for the business is essential
when it comes to financing.

Understanding Debt and Equity Capital

Debt is anything owed, especially a sum of money, that one person

owes to another. A person who owes a debt is the debtor, and the one to
whom it is owed is the creditor. If the debtor is unwilling or unable to pay the
debt, the creditor may bring suit to recover the money. If the court finds that
the debt is owed, and if the debtor fails to pay, the creditor may appeal to the
sheriff for an execution of judgment. This gives the creditor the right to seize
enough property of the debtor to pay the debt and the cost of the process. But
there are exceptions as to what may be seized. This law varies in different
states, provinces, and territories.
Equity capital or financing is money raised by a business in exchange
for a share of ownership in the company. Ownership is represented by owning
shares of stock outright or having the right to convert other financial
instruments into stock of the private company. Equity capital refers to money
that you and any business associate inject directly into the operation. If your
operation is a sole proprietorship or a partnership, this type of financing Would
likely be in the form of an owner's contribution and Would appear on the
balance sheet as owner's equity. If your business is incorporated, anyone
contributing equity capital would receive shares in the business. Equity capital
results in some degree of ownership to those making the contribution.

Features of Debt and Equity Capital

Feature of Debt

In a special type of debt called secure debt, the debtor promises that,
if the debt is not paid on time, the creditor may seize specified property from
the debtor before a suit is brought. If the value of the property is not enough to
pay the entire debt, the creditor may then sue the debtor for the remaining
amount. Most people purchase such expensive items as homes and
automobiles through secured debt agreements. Time limits on collection of
debt. The courts ordinarily state that debtors should pay their debts, even
though the creditor does not demand payment. But if the creditor makes no
effort to collect the money within a certain number of years, the debt becomes
barred by a statute of limitations and can no longer be collected.

Feature of Equity

Two key sources of equity capital for new and emerging business are
investors and venture capital firms.
Typically, capital and venture capital investors provide capital
unsecured by assets to young private companies with the potential for rapid
growth. Such investing covers most industries and is appropriate for business
through the range of developmental stages. Investing in new or very early
companies inherently carries a high degree of risk. But venture capital is long-
term to “patient capital", that allows companies the time to mature into
profitable organizations.
Venture capital is an active rather than passive form of financing.
These investors seek to add value, in addition to capital, to the companies in
which they invest in an effort to help them grow and involvement a greater
return on the This requires active involvement and almost all venture
capitalists will, at a minimum, want a seat on the board of directors.
Although investors are committed to a company for the long haul, that
does not mean indefinitely. The primary objective of equity investors is to
achieve a superior rate of return through the eventual and timely disposal of
investments. A good investor will be considering potential exit strategies.
Venture capitalists expect two things from the companies they finance
— high returns and a method of exit. Since venture capitalists hit the jackpot
with only a small percentage of the companies they back, they must go into
each deal with the possibility of a return of five to ten times their investment in
three to five years if the company is successful. This may mean that they will
own anywhere from 25 to 70 percent or more of your company. Each situation
is different, and the amount of equity the venture capitalist will hold depends
on the stage of the company's development at the time of the investment, the
risk perceived, the amount of capital required, and the background of the
entrepreneur. The first meeting with the venture capitalist is very important.
The presentation of a business plan, one's appearance, conduct, what to say
and how to say it are all critical. Preparedness is vital. There are many
questions about a business plan.
Once a decision is made to finance a firm, the actual investment by the
venture capitalist is negotiable and can take one of the variety of forms. These
range from a straight common stock purchase to dentures with conversion
features to straight loan. Venture capitalists usually use a combination of
investment instruments to structure the deal will be most beneficial to both
parties.
Differences Between Debt and Equity Capital
 Debt capital is represented by funds borrowed by a , business that
must be repaid over a period of time, usually with interest. Debt financing can
be either short-term, with full and timely disposal of investment first presented
and investigated.
Equity capital is represented by funds that are raised by a business, in
exchange for a share of ownership in the company. Equity financing allows a
business to obtain funds without incurring debt, or without having to repay a
specific amount of money at a particular time.
The term capital denotes the long-term funds of the firm. All items on
the right-hand side of the firm's balance sheet, excluding current liabilities are
sources of capital. Debt capital includes all long-term borrowing incurred by
the firm, including bonds. Equity capital consists of funds provided by the
firm’s owners, the stockholders. Equity capital can be raised internally through
retained earnings, or externally by selling common or preferred stocks.

Maturity
Unlike debt, equity is a permanent form of financing. It does not
"mature" and will be liquidated only during bankruptcy proceedings. The
owners must recognize that although a ready market may exist for the firm's
shares, the price that can be realized may fluctuate. This potential fluctuation
of the market price of equity makes the overall returns to a firm's owners even
more risky.

Tax Treatment
Interest payments to debt holders are treated as tax-deductible
expenses on the firm's income statement, whereas dividend payments to
common and preferred stockholders are not tax deductible. The tax
deductibility of interest lowers the cost of debt financing to be lower than the
cost of equity financing.

Debt and Equity as Investments

What is the life of an investment?
There is a wide range of investment vehicles available to the investor
such as securities, mutual funds, property and others.
Investment in securities represents either a debt or the promise that the
loan equity interest. Debt represents finds borrowed in exchange for receiving
interest income and promise that the loan will be repaid at a future date.
Bonds and commercial papers will be repaid at a given are examples of debt
securities. Equity represents a current ownership interest in a specific
business or property, business Typically, an investor obtains an equity interest
in a business by buying securities collectively known as stock (i.e., common,
preferred, and convertible preferred).
 Debt securities are similar to bank loans, in that the corporation
promises to pa y the face value on the maturity date together with interest
payments at regular intervals. But unlike a bank loan, bonds and commercial
papers are represented by certificates which are handed over to the buyer
who becomes the holder of the certificates. In this way, stocks are also similar
to debt securities a stock certificate is issued but differ in a way that the
issuing company does not have the obligation to pay interest to the holder or
repay the face value of the stock. The investor also has a choice, of which
type of securities to invest in depending on such considerations like cost, rate
of return, risk involved and taxes to be paid.

Debt Readjustments
Readjustment involves fundamental changes in the capital structure,
such as changes in preferred stock provisions, bonds, or the corporate
structure of a parent company and its subsidiaries. Any debt readjustment
must be accomplished by persuading the creditors that it is to their interest
and advantage to follow a proposed plan of readjustment.

Long-term Debt
The amount of long-term debt on a company’s balance sheet is
crucial. It refers to money the company owes that it does not expect to pay off
in the next year. Long-term debt consists of things such as mortgages on
corporate buildings and/or land, as well as business loans.
A great sign of prosperity is when a balance sheet shows the amount
of long-term debt to be decreasing for one or more years. When debt shrinks
and cash increases, the balance sheet is said to be "improving."
When it is the other way around, it is said to be "deteriorating."
Companies with too much long-term debt will find themselves overwhelmed
with interest payments, a risk of having too little working capital, and
ultimately, bankrupt Thankfully, there is a financial tool that can tell if a
business has borrowed too much money.

Debt to Equity Ratio

The debt to equity ratio measures how much money a company should
safely be able to borrow over long periods of time. It does this by comparing
the company's total debt (including short-term and long-term obligations) and
dividing it by the amount of owner's equity. The result you get after dividing
debt by equity is the percentage of the company that is indebted (or
"leveraged"). The normal level of debt to equity changes over time, and
depends on both economic factors and society's general feeling wards credit.
Generally, any company that has a debt to equity ratio of over 40% to 50%
should be looked at more carefully to make sure there are no liquidity
problems. If you and the company's working capital, and current/ quick ratios
drastically low, this is a sign of serious financial weakness.
Profitable Borrowing

Return on Equity
If a business 'can earn a higher rate of return than the interest rate at
which it borrows, it becomes profitable for the business to borrow money. (An
example: If a corporation earned 15% on its investments and borrowed funds
at 8%, it would make 7% on the borrowed money [15% return - 8% cost of
money 7% net profit]. This boost is what analysts call "Return on Equity."

Debt or Equity?
What kind of money is right for business? Debt capital is generally
cheaper than equity capital in the long run, and is typically quicker and easier
to find. The real advantage to debt financing is that it does not dilute
ownership. The disadvantage of debt capital is that lenders require regular
monthly payments of principal and interest regardless of profitability.
Investors on the other hand are, almost by definition, willing to gamble
on a company's success. Early in the life of a company, investors usually do
not expect a return on their money, because they are really hoping for a huge
success in three to seven years. As owners, investors also share in the risk of
failure. Creditors may not require monthly payments, but they will be checking
on company performance to make sure the company is doing what it
promised it would.
Incidentally, while the concept of financing a business purely on Other
People's Money or OPM has been widely touted by a number of self-
appointed gurus, it rarely works that way in the real world. First, the Coopers
and Lybrand study found that only about thirteen percent of companies found
someone to invest money in their start-up. (And remember, those statistics
were based_ fast growing and service coma growing nies. One can be sure
that the chance of a slow- p growth retail of distribution company being
financed by an investor is much lower, which makes lenders to shy away from
what they call an "under-capitalized" company, one where the owners have
too little or their own money at risk. One's investment in a company is a
lender's best guarantee of one's commitment through thick and thin.
Here are some questions to consider when deciding between debt and
equity financing:
Debt:
 Will the company qualify for debt financing?
 What terms and conditions will be placed on the debt?
 Are we willing to personally guarantee the debt?
  Are we willing to pledge company and personal assets as collateral?
 Will we have the cash flow to support new debt?
 Will we be able to afford the new debt if interest rates rise or business
slows? What is my after-tax cost of borrowing money?
 Can we produce the necessary reports to comply with loan terms?
 Can we accurately predict our future cash flow?
 Can we comply with all covenants and conditions?
 Can we obtain enough debt financing to achieve our growth plans?
 Will new debt increase our leverage so much that it will hurt our credit
rating with vendors and others?

Debt Versus Equity

Liabilities are obligations of the firm that require a Payout of cash within
a stipulated time period. Many liabilities involve contractual obligations to
repay a stated amount and interest over a period. Thus, liabilities are debt and
are frequently associated with nominally fixed cash burdens, called debt
service, that put the firm in default cash of a contract if they are not paid.
Stockholder's equity is a claim against the firm's assets that is residual and
not fixed. In general terms, when the firm borrows, it gives the bondholders
first claim on the firm's cash flow. Bondholders can sue the firm if the firm
defaults on its bond contracts. This may lead the firm to declare itself
bankrupt. Stockholders' equity is the residual difference between assets and
liabilities:

Assets — Liabilities = Stockholder's Equity

This is the stockholder's share in the firm stated in accounting terms.

The accounting value of stockholder's equity increases when retained
earnings are added. This occurs when the firm retains part of its earnings
instead of paying them out as dividends.

Corporate Long-Term Debt: The Basics

Securities issued by corporations may be classified roughly as equity
securities and debt securities. The distinction between equity and debt is
basic to many of the modern theory and practice of corporate finance. At its
crudest level, debt represents something that must be repaid; it is the result of
borrowing money. When corporations borrow, they promise to make regularly
scheduled interest payment and repay the original amount borrowed (that is,
principal). The person of firm making the loan is called a creditor or lender

Interest versus Dividends

The corporation borrowing the money is called a debtor or borrower.
The amount owed by the creditor is a liability of the corporation; however, it is
a liability of limited value. The corporation can legally default at any time on its
liability. This can be a valuable option. The creditors benefit if the assets have
a value greater than the value of the liability, but this would happen only if
management were foolish. On the other hand, the corporation and the equity
investors are able to walk away from the liabilities and default on their
payment.
From a financial point of view, the main differences between debt and
equity are the following:

1. Debt is not an ownership interest in the firm. Creditors do not usually

have voting power. The device used by creditors to protect themselves is the
loan contract (that is, the indenture).

2. The corporation's payment of interest on debt is i considered a cost

of doing business and is fully tax-deductible. Thus, interest expenses are paid
out to creditors before the corporate tax liability is computed. Dividends on
common and preferred stock are paid to shareholders after the tax liability has
been determined. Dividends are considered a return to shareholders on their
contributed capital, because interest expense can be used to reduce taxes.
The government is providing a direct tax subsidy on the use of debt when
compared
To equity.
3. Unpaid debt is a liability of the firm. If it is not paid, the creditors can
legally claim the assets of the firm. This action may result in liquidation and
bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial
failure, which does not arise when equity is issued.

Is It Debt or Equity?
Sometimes it is not clear whether a particular security is debt or equity.
Suppose a 50-year bond is issued with interest payable solely from corporate
income if and only if earned, and repayment is subordinate to all other debts
of the business. Corporations are very adept at creating hybrid securities that
look like equity but are called debt. Obviously, the distinction between debt
and equity is important for tax to create a debt security that is really equity.
They are trying to obtain the tax benefits of debt while eliminating the
bankruptcy costs.

Different Types of Debts

Typical debt securities are called notes, debentures, or bonds. A
debenture is an unsecured corporate debt, whereas a bond is secured by a
mortgage on the corporate property. However, in common usage, the word
"bonds" is used indiscriminately and often refers to both secured and
unsecured debt. A note usually refers to an unsecured debt with maturity
shorter than that of a debenture, perhaps less than ten (10) years.
Debentures and bonds are long-term debt. Long-term debt is any obligation
that is payable more than one year from the date it was originally issued.
Sometimes long-term debt—debentures and bonds—is called funded debt.
Debt that is due in less than one year is unfounded and is accounted for as a
current liability. Some debts are perpetual and have no specific maturity.
These types of debts are referred to as a consol.

Repayment
Long term debts is typically repaid in regular amounts over the life of
the debt. The payment of long-term debt by installments is called
amortization. At the end of the amortization, the entire indebtedness is said to
be extinguished. Amortization is typically arranged by a sinking fund. Each
year, the corporation places money into a sinking fund, and the money is used
to buy back the bonds.
Debt may be extinguished wished issued corporate long-term
Historically, almost all publicly debt has been callable. These are debentures
or bonds for which the firm has the right to pay a specific amount, the p call
price, to retire (extinguish) the debt before the stated maturity date. The call
price is always higher than the par value of the debt. Debt that is callable at
105 is debt that the firm can buy back from the holder at a price of P1,050 per
debenture or bond, regardless of what the market value of the debt might be.
Call prices are always specified when the debt is originally issued.
However, lenders are given a 5-year to 10-year call-protection period during
which the debt cannot be called away. Recently, there has been higher
incidence of no callable offerings.

Seniority
In general terms, seniority position over other lenders. Some debt is
subordinated. In the event of default, holders of subordinated debt must give
preference to other specified creditors. Usually, this means that the
subordinate lenders will be paid off only after the specified creditors have
been compensated. However, debt cannot be subordinated to equity.

Security
Is a form of attachment to property; it provides that the property can be
sold in the event of default to satisfy the debt for. which. security is given. A
mortgage is used for security in tangible property; for example, debt can be
secured by mortgages on plant and equipment. Holders of such debt have
prior claim on the mortgaged property and is sold in the event of default.
Debenture holders will obtain something only where the mortgage
bondholders have been fully satisfied.

Indenture
 The written agreement between the corporate debt issuer and the
lender, setting forth maturity date, interest date, and all other terms, is called
an indenture.
These are some notes to remember:

The indenture completely describes the nature of the indebtedness.

Some typical restrictive covenants are the following:
1. Restrictions on further indebtedness;
2. A maximum on the amount of dividends that can be paid;
3. A minimum level of working capital.

Introduction

Knowing where to invest, how much money to put in as well as proper

timing are key ingredients in making sound investment decisions. One has to
be well grounded on the macro and micro level of the political and business
climate of the country where one is investing funds. Being familiar with the
various securities being offered in the market is an advantage.

Need to Keep Track of Investment

Having placed some amount in stocks, one should spend some time
and effort in studying his investment. He should keep track of the stock price
and follow closely the developments of the company. This way, he would be
able to foresee possible gains or losses that will guide him in making sound
and wise investment decisions. Daily quotations of stock prices can be
obtained from a stockbroker or from all leading newspapers.

Ways of Profiting in the Stock Market

Investors can profit in the stock market thru any or a combination of the
following

 Capital Gains - are profits made due to an increase in the market price
of a stock from the buying price.

 Cash Dividend - a dividend given to share-holders in the form of cash.

It is computed by multiplying the number of shares held by the cash
dividend rate declared.
  Stock Dividend - a dividend given to share-holders in the form of
additional stocks. It is computed by multiplying the number of shares
held by the percentage of the stock dividend declared.

 Stock Rights - stock rights offering is the option given to the present
shareholders to buy additional shares of stock at a price lower than its
market price.

Risk Involved in Investing

Risk is always a part of any investment. And because stock investment

is the most volatile, a better attitude would loss should be to limit the risk. A
maximum level of gain should be set and decisions should be made when this
level is reached.

Classification of Stocks

 Blue Chip Stocks - high-grade issues of major companies that have a

long and favorable history of earnings and dividend payments. The
term is used to describe common stock of well-established and mature
corporations that are in excellent financial health.

 Growth Stock - stock of corporations whose sales, earnings and market

shares are expanding faster than the general economy and their
industry. Growth corporations usually retain most of their earnings to
finance research and expansion. As a result, these corporations
generally have small dividend payouts.

 Defensive Stocks - characterized by their degree of stability during

periods of a declining economy. Examples are corporations involved in
essential products and services (food electricity, gas, etc.).

 Cyclical Stocks - stocks of corporations whose earnings fluctuate with

the business cycle. Also referred to as stocks that are highly dependent
on the state of the economy. Examples: airline, hotel, steel, cement,
automobiles, etc.

Portfolio Management

1. Functions of Portfolio Management - A Certified Securities

Representative is the one expected to help clients choose from the many
securities products available that are best suited to their individual needs and
investment objectives. When one attempts to meet investment needs by
selecting securities for a portfolio, he is engaging in portfolio management.
The four principal functions of portfolio management are:

 Establishing the Plan for the Portfolio -involves the establishment of a

plan or policy statement incorporating the client's investment objectives
and constraints.

 Selection of Securities - entails the analysis and selection of securities

to be purchased in accordance with the investment plan.

 Buying and Selling of Securities - includes the actual buying and selling
of securities as required to keep the portfolio at peak effectiveness in
fulfilling the investment objectives of the investor.

 Continuing Supervision of the Securities Purchased - involves a

periodic appraisal of the securities held in the portfolio. Super-vision is
also concern with such details as watching for notices of redemption,
rights offerings and the checking of interest and dividend payments.

2. The Portfolio and Its Composition

a. Definition - The portfolio is a planned selection of securities, put together to

achieve specific purposes for the owner. To be most effective, the portfolio
should be tailored, to the investment goals of the person concerned. Each
security in the portfolio has a definite contribution to make towards satisfying
the investor's requirements as to safety of principal, current income growth of
capital, and liquidity.

b. Investor Requirements

 Safety - Nobody wants to lose money. But some people are more risk
averse than others and safety of principal for them is a prime
consideration in choosing investments.

 Current Income - Some people, especially retired individuals, require a

constant stream of income from their investments because they need it
for living expenses.

 Growth of Capital - Some investors do not really need current income

and are more interested in maximizing the returns on their investments
 so that they have a better chance to achieve their long-term financial
goals such as augmenting retirement income or sending their children
to college.

 Liquidity - Some investors want or need to be able to readily convert

some of their investments into cash so they invest a portion of their
portfolio in securities that are liquid or marketable.

c. Compromises - The typical portfolio is a compromise of investment for

safety of principal, income, capital appreciation, and liquidity. The compromise
achieved depends upon the investor's personal circumstances and investment
objectives. For one investor to adopt an investment program and portfolio
developed for another is to invite mediocre results, unless adjusted
appropriately to meet his own situation.

3. Analyzing the Investor

a. Individual Investors — No two individuals have exactly the same goals, risk
tolerance, financial resources, and personal circumstances. It is therefore
necessary to find out basic information about the client so that an investment
plan can be developed to suit his unique requirements.

 Dependents - The investor who has other persons dependent upon

him must provide for such things as a home, life and sickness
insurance, and the education of the dependents. The presence of
dependents throws the investment program towards a conservative
policy. Funds must be accumulated for insurance premiums, mortgage
payments, school fees and cash emergency fund must be maintained.
 Age - Younger investors can afford to assume more risks and develop
long-range plans because they have more time to make up for
possible bad investments. The older investors are usually more
dependent upon investment income and are therefore more
conservative because lost capital cannot be readily replaced.

 Financial Resources - Persons with substantial amounts of capital can

afford to assume certain investment risks that are otherwise
unacceptable to small investors. They can also obtain adequate
diversification to hedge the investment risk.

 Income Characteristics - Most fixed-income earners have some form

of pension to look forward to upon their retirement. This pension may
not be sufficient to cover their entire expenses when they retire but at
least they have an assured source of income. Self-employed
 individuals, on the other hand, may have to set aside more funds
during their working years to prepare for their retirement.

 Temperament — Some persons are better suited than others in

making investment decisions and the management of a portfolio.
Some people worry if they purchase common shares. Others enjoy
risk taking and thrive on the prospect of capital gain. Those who prize
investment with peace of mind should own portfolio that emphasizes
safety of principal and continuity of income.

 Taxation - In other countries, the effect of taxes dominates the

individual's investment program.

 Ability to Supervise Investments - Most investors do not have the time,

knowledge or capability to supervise their investments. The certified
securities representative must therefore be pre-pared to assist
investors in making decisions necessary for the maintenance of an
effective portfolio.

 Financial Affairs — Since the investment program is part of a client's

overall financial affairs, the certified securities representative should
attempt to determine the scope of the client's affairs. Such factors as
the amount of insurance he carries, the pension plans in which he
participates and the other investments he may have (such as mutual
fund shares and real estate holdings) are circumstances of which the
certified securities representative should be aware in order to give
suitable advice about an investment program.

b. Institutional Investors — Institutional investors differ from individual

investors in many ways. They are usually more sophisticated and discerning.
While individual investors generally define risk as the probability of losing
money, institutional investors view risk as the standard deviation (or
variability) in returns. Individuals are usually free to act as they wish while
institutions are typically encumbered by the demands of fiduciary
responsibility and other legal constraints. Just as there are diverse kinds of
individuals, there are also different types of institutions with varied return
requirements, time horizons, and liquidity needs.

 Corporations - Non-financial corporations do not t no usually invest in

long term instruments because they merely want to temporarily park
their idle funds in securities that offer slightly higher returns than bank
savings account rates. Their liquidity requirements are high because
they usually need the funds for their operations. As a result,
 corporations normally stick to short-term government securities (T-Bills)
and time deposits.

 Pension/Retirement Funds - Employee retirement plans are either

defined benefit or defined contribution. In the Philippines, most
retirement plans are of the defined benefit type because companies are
required under retirement laws to provide certain benefits for retiring
employees with at least ten (10) years of service. Regardless of the
type, funded retirement funds generally have long time horizons and
are invested in a wider array of investment products than ordinary
corporations.

 Banks - Unlike pension funds, bank funds that are available for
investment are not cost-free. They have to pay interest to their
depositors so they expect a return on investment that is reasonably
higher than their cost of borrowing. They also have to contend with
reserve requirements, which raises their cost of borrowing and
accordingly their rate of return expectations. In short, banks generally
invest on the basis of spreads or margins. Liquidity requirements are
generally high and dictated by withdrawals by depositors and loans to
clients.

 Insurance Companies — Life insurance companies have often been

regarded as the classic long-term investor. Annual cash inflows usually
exceed cash outflows so liquidity requirements are minimal. The long
time horizon of insurance companies allows them to hold 20-year and
30-year bonds until maturity. Although generally conservative,
insurance companies also invest in a diversified pool of investments to
improve earnings and increase surplus. Return expectations are
primarily actuarially determined.

 Investment Companies - Investment companies differ from other

institutional investors because they are regarded more as conduits for
investment funds. The fund's investment objectives and policies dictate
their return expectations, liquidity requirements, and diversity of
investments. For instance, money market funds are limited to short-
term debt instruments and have very high liquidity requirements.
Balanced fund on the other hand, have longer time horizons, lower
liquidity needs, higher return expectations, and ma more diversified
portfolio.
TVM FORMULA:

FV= PV (1+rt)
FV
PV= 1+ rt