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Capital
From the realm of economics and politics to the world of finance, accounting
and business, capital is one of the most ambiguous word. It can mean cash or long-
term assets, or all sources of long-term funding. Capital must be perceived as a
solid foundation but complicated backbone of every business. Capital must not
sleep but rather it should spread and trickle to those who can further bolster and
strengthen it. As capital can grow very big to be managed by an individual, there is
a need to form entities under the law to maximize the potential gain and further
increase of it.
The word "corporation" derives from corpus, the Latin word for body, or a
"body of people." Entities which carried on business and were the subjects of legal
rights were found in ancient Rome, and the Maurya Empire in ancient India2. In
medieval Europe, churches became incorporated, as did local governments, such as
the Pope and the City of London Corporation. The point was that the incorporation
would survive longer than the lives of any particular member, existing in perpetuity.
The alleged oldest commercial corporation in the world, the Stora Kopparberg
mining community in Falun, Sweden, obtained a charter from King Magnus Eriksson
in 1347. Many European nations chartered corporations to lead colonial ventures,
such as the Dutch East India Company or the Hudson's Bay Company, and these
corporations came to play a large part in the history of corporate colonialism.
During the period of colonial expansion in the seventeenth century, the true
progenitors of the modern Corporation emerged as the "chartered company". Acting
under a charter sanctioned by the Dutch monarch, the Dutch East India Company
(VOC), defeated Portuguese forces and established itself in the Moluccan Islands in
order to profit from the European demand for spices. Investors in the VOC were
issued paper certificates as proof of share ownership, and were able to trade their
shares on the original Amsterdam stock exchange. Shareholders are also explicitly
granted limited liability in the company's royal charter.3 In the late eighteenth
century, Stewart Kyd, the author of the first treatise on corporate law in English,
defined a corporation as:
2
Vikramaditya S. Khanna (2005). The Economic History of the Corporate Form in Ancient India.
University of Michigan.
3
Om Prakash, European Commercial Enterprise in Pre-Colonial India (Cambridge University Press,
Cambridge 1998)
1
an individual, particularly of taking and granting property, of contracting
obligations, and of suing and being sued, of enjoying privileges and
immunities in common, and of exercising a variety of political rights, more or
less extensive, according to the design of its institution, or the powers
conferred upon it, either at the time of its creation, or at any subsequent
period of its existence.4
Institutions are also part of the framework of the capital market. Stock
exchanges are one of the more visible examples of established operations that give
form and function to the capital market. Along with the stock exchanges, support
organizations such as brokerage firms also form part of the capital market. Over the
counter markets are also included in the working definition for a capital market. By
providing the mechanisms that make trading possible, these outward expressions of
the capital market make it possible to keep the process ethical and more easily
governed according to local laws and customs.6
Despite the growing economy, the Philippines will have to address several
chronic task in the future. Strategies for streamlining the economy include
improvements of infrastructure, more efficient tax systems to bolster government
revenues, furthering deregulation and privatization of the economy, and increasing
trade integration within the region and across the world.
The Philippine economy is also heavily reliant on remittances as a source of
foreign currency, surpassing even foreign direct investment. China and India have
emerged as major economic competitors, siphoning away investors who would
otherwise have invested in the Philippines, particularly telecommunications
4
A Treatise on the Law of Corporations, Stewart Kyd (1793-1794)
5
Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River,:
Pearson Prentice Hall. pp. 283. ISBN 0-13-063085-3
6
http://www.wisegeek.com/what-is-the-capital-market.htm
7
Philippine Capital Markets Conference: http://www.iacc.tpgi.org/phils2009/genpage.asp
2
companies. Regional development is also somewhat uneven, with Luzon and Metro
Manila in particular gaining most of the new economic growth at the expense of the
other regions, although the government has taken steps to distribute economic
growth by promoting investment in other areas of the Philippines.
Investment Banks
Unlike commercial banks and retail banks, investment banks do not take
deposits.8
Persons who effect underwriting9 are called investment bankers. One of the
most important functions of the investment banker is to give financial advice to help
the corporation determine, how much money it needs, should money be raised; and
through issuance of securities10, what type of securities and when should the
securities be offered for sale. Once these decisions have been made, the
investment banker and the issuer must work together to meet the legal
requirements for the issuance of securities.
8
From Wikipedia, the free encyclopedia
9
Underwriting is the process that a large financial service provider (bank, insurer, investment house)
uses to assess the eligibility of a customer to receive their products (equity capital, insurance,
mortgage, or credit); the purchase of a new issue from the issuing corporation at a fixed price and the
reselling of such issue to the public.
10
To be further discussed next chapter.
3
The investment banker who gives financial advice to a corporation normally
assists in the marketing of any securities the firm decides to issue. Marketing
securities s risky, since factors such as market fluctuations and possible lack of
investor interest may result in failure to sell all of the securities being offered, and
thereby, failure to raise the capital needed by the issuing corporation. Thus, it is
beneficial for the issuer to use an investment banker, not only as a source of advice,
but as marketer of its securities.
In the Philippines, only investment houses duly registered with the Securities
and Exchange Commission, complying with the Investment House Laws, and other
banks with expanded banking licenses are authorized to underwrite securities.11
There are generally two-types of equity securities that the public may
purchase: common stock and preferred stock. Both common and preferred stock
are called equity securities because they represent ownership in the corporation
and without maturity dates. As a unit of ownership, common stock typically carries
voting rights that can be exercised in corporate decisions. Preferred stock differs
from common stock in that it typically does not carry voting rights but is legally
entitled to receive a stated rate of return or a certain level of dividend payments,
which is a percentage of its par value, before any dividends can be issued to other
shareholders. The declaration of dividends is at the sole discretion of the Board of
Directors of the corporation. All stock corporations issue at least one class of
common stock in the form of shares.
11
Business Finance (Phil. Environment) by Manuel M. Dela Cruz (2005)
12
http://www.wisegeek.com/what-are-equity-securities.htm
13
From Wikipedia, the free encyclopedia
4
Characteristics and Features of Common Stock:14
3. Voting Rights – Each holder of voting stock of a corporation has the right
to attend meetings and vote on important matters, such as election of the
Board of Directors. Stockholders, who cannot attend meetings, may vote
by proxy. There are two methods of handling allocation of votes:
a. Statutory Voting – a stockholder may vote, for every directorship, a
maximum number of votes equal to the number of shares he owns.
4. Stock Splits – corporations may split their stock, which increases the
number of authorized shares and decreases the par value. For this reason,
stock splits require stockholders approval and amendment of the Articles
of Incorporation.
6. Warrants – these are similar to rights, except that the corporation does
not issue them specifically to a stockholder, but sells them to general
revenue. Warrants are longer term; require delivery and a fixed
subscription price to purchase a specified number of common shares. At
issue, the subscription price is always higher than the market price.
However, they do have a market value based on what investors believe
are the prospects of the common stock rising in market value over the
lifetime of the warrants.
14
Business Finance (Phil. Environment) by Manuel M. Dela Cruz (2005)
5
a. Blue Chip Stocks – high grade issues of major companies that have long and
favorable history of earnings and dividend payments. The term is used to
describe common stock of well-established, mature corporations that are in
excellent financial health.
2. Market Risk – the risk of a single stock as measured by its volatility (the
fluctuation in its price relative to the market) actually of two components:
15
Business Finance (Phil. Environment) by Manuel M. Dela Cruz (2005)
16
Business Finance (Phil. Environment) by Manuel M. Dela Cruz (2005)
6
unsystematic risk or company-specific risks and systematic risk or market-
related risk. The former is the variability in the stock’s price due to factors
associated with the company while the latter is the variability in price related
to the ups and downs of the stock market as a whole.
4. Liquidity Risk Interest Rate Risk – this is the risk that an investment may
not find a ready buyer or that it may have to be disposed at a substantial
loss. The prices of longer-term bonds are more affected by changes in
interest rates than shorter-term bonds. Stocks, however, are generally more
volatile in price than bonds and are therefore more susceptible to this type of
risk. To reduce this risk, investors should try to stay away from securities
which: 1) do not have a ready market; 2) are not listed; 3) are listed but not
actively traded; and 4) are very volatile.
5. Interest Rate Risk – this refers to the volatility of bond prices that result
from changes in interest rates. If bonds are purchased and interest rates
subsequently rise, then the prices of the purchased bonds will decline. If the
fund is not willing to sell at these low levels, then it is “stuck” with the low
interest on the purchased bonds and cannot participate in the higher rates
now being earned. Lower interest rates adversely affect the yield on money
market instruments and funds.
6. Credit Risk – this refers to the “creditworthiness” of the bond issuer and its
expected ability to pay interest and to repay the principal upon maturity. A
decline in an issuer’s credit rating can cause a bond’s price to decline.
7. Purchasing Power Risk – this is the risk of inflation or the risk that the
value of one’s money in real terms will be less than the purchasing power of
your original investment. This is particularly true when investing in fixed-
income securities whose interest rates are consistently below the rate of
inflation.
8. Call Risk – also called pre-payment risk and is the possibility that a bond will
be called away from the investors by the issuer before its maturity date. This
usually happens when interest rates drop and the issuer has an opportunity
to borrow money at a lower rate than the one current being paid. As a
consequence, the bond holder will not receive anymore interest payments
from the investment and may be forced to reinvest his money at lower rates.
Prepared by:
Benjamin O. Albano
2008-0210