 Case 2

Michael who works as a waiter in a five-star hotel in the Philippines wants to make a
nominal investment from his savings in the stock market in pursuit of higher gains. The problem
is that he does not have enough knowledge on how to invest in the stock market wisely. As a
result, he went to a financial consultant and asked for help.

STATEMENT OF THE PROBLEM

 Determine and discuss the steps involved in investing in the securities market
 Identify alternatives where Michael can invest his savings, the process and which financial
intermediaries he can go to.

BACKGROUND INFORMATION

Michael plans to make a nominal investment from his savings, in this case he wanted to
become a participant in the market, playing the role of a lender. In order to achieve his objective
which is to get higher gains from returns on his investment, he will be needing an issuer where
he could buy instruments that he can invest on. This cannot be done without the help of a
financial market or financial intermediary which facilitates the transfer of funds between the
issuer and the investor.

A Securities market is an exchange where sale and purchase transactions of securities

are conducted on the base of demand and supply. A well-functioning securities market should be
able to provide timely and accurate information on the past transactions, liquidity, low
transaction costs (internal efficiency) and securities prices that rapidly adjusted to all available
information (external efficiency).

There are two level of securities markets:

 Primary Market is the market for new securities issues and is facilitated by underwriting
groups. The companies sell their securities to the public directly to the investors through the
underwriters (normally investment banks for stock and bond issuance). When the firm is
issuing shares for the very first time, it is called Initial Public Offering (IPO). New shares
issued by firms whose shares are already trading in the market are called seasoned or
secondary issues. Issuing company receives cash from the sale and uses it to expand or fund
the operations. After the initial sale, the securities trading will be conducted on the secondary
market.
 Secondary market, also known as the aftermarket, is the market where the trading of the
previous issued securities is conducted. On a secondary market, an investor buys securities
from another investor instead of the issuer. It is important that the secondary market provides
liquidity and therefore provides continuous information about the market price of the
securities.

A security is a financial instrument, typically any financial asset that can be traded. The
nature of what can and can’t be called a security generally depends on the jurisdiction in which
the assets are being traded.

Types of Security:

1. Equity almost always refers to stocks and a share of ownership in a company (which is
possessed by the shareholder). Equity securities usually generate regular earnings for
shareholders in the form of dividends. An equity security does, however, rise and fall in value
in accord with the financial markets and the company’s fortunes.
2. Debt securities differ from equity securities in an important way; they involve borrowed
money and the selling of a security. They are issued by an individual or company and sold to
another party for a certain amount, with a promise of repayment plus interest. They include a
fixed amount (that must be repaid), a specified rate of interest, and a maturity date (the date
when the total amount of the security must be paid by).

Bonds, bank notes (or promissory notes), and Treasury notes are all examples of debt
securities. They all are agreements made between two parties for an amount to be borrowed
and paid back – with interest – at a previously-established time.
3. Derivatives are a slightly different type of security because their value is based on an
underlying asset that is then purchased and repaid, with the price, interest, and maturity date
all specified at the time of the initial transaction.

The individual selling the derivative doesn’t need to own the underlying asset outright. The
seller can simply pay the buyer back with enough cash to purchase the underlying asset or by
offering another derivative that satisfies the debt owed on the first.

A derivative often derives its value from commodities such as gas or precious metals such as
gold and silver. Currencies are another underlying asset a derivative can be structured on, as
well as interest rates, Treasury notes, bonds, and stocks.

Derivatives are most often traded by hedge funds to offset risk from other investments. As
mentioned above, they require the seller to own the underlying asset and may only require a
relatively small down payment, which makes them favorable because they are easier to trade.

A financial intermediary is an entity that acts as the middleman between two parties in a
financial transaction, such as a commercial bank, investment banks, mutual funds and pension
funds. Financial intermediaries offer a number of benefits to the average consumer, including
safety, liquidity, and economies of scale involved in commercial banking, investment
banking and asset management. Although in certain areas, such as investing, advances in
technology threaten to eliminate the financial intermediary, disintermediation is much less of a
threat in other areas of finance, including banking and insurance.

A financial intermediary performs the following functions:

1. Asset storage
 Commercial banks provide safe storage for both cash (notes and coins), as well as precious
metals such as gold and silver. Depositors are issued deposit cards, deposit slips, checks, and
credit cards that they can use to access their funds. The bank also provides depositors with
records of withdrawals, deposits, and direct payments they have authorized. To ensure the
depositors’ funds are safe, the Federal Deposit Insurance Corporation (FDIC) requires
deposit-taking financial intermediaries to insure the funds with them.

2. Providing loans

Advancing short-term and long-term loans is the core business of financial intermediaries.
They channel funds from depositors with surplus cash to individuals who are looking to
borrow money. Borrowers typically take out loans to purchase capital-intensive assets such
as business premises, automobiles, and factory equipment.

Intermediaries advance the loans at interest, some of which they pay the depositors whose
funds have been used. The remaining amount of interest is retained as profits. Borrowers
undergo screening to determine their creditworthiness and their ability to repay the loan.

3. Investments

Some financial intermediaries, such as mutual funds and investment banks, employ in-house
investment specialists that help clients grow their investments. The firms leverage their
industry experience and dozens of investment portfolios to find the right investments that
maximize returns and reduce risk.

The types of investments range from stocks to real estate, Treasury bills, and financial
derivatives. Sometimes, intermediaries invest their clients’ funds and pay them an annual
interest for a pre-agreed period of time. Apart from managing client’s funds, they also
provide investment and financial advice to help them choose ideal investments.

Nominal Investment

Nominal is a common financial term with several different contexts. In the first, it means
very small or far below the real value or cost. In finance, this adjective modifies words such as a
fee or charge. A nominal fee is below the price of the service provided or presumably easy for a
consumer to afford, or a fee that is small enough that it does not have any meaningful impact on
one's finances.

In finance and economics, nominal may also refer to an unadjusted rate or the change in
value. When defining items like the gross domestic product (GDP) or interest rates, nominal
points to a figure that is unadjusted for seasonality, inflation, interest compounding, and other
modifiers. In this use, nominal shows the contrast to "real" economic statistics that do make such
adjustments or modifications to results.

Consultants are paid to share their expertise and knowledge to help businesses attain goals and
solve problems. Businesses often hire consultants to supplement their staff and save the costs of
hiring a full-time employee. As a person new to the company or organization, consultants view
the situation from a fresh perspective. Because a consultant isn't beholden to any particular
corporate culture, co-worker scrutiny or morale, consultants can act as the catalyst for change.
While there are no degree requirements for a consultant, they do need to have vast knowledge
and experience in a particular field. In addition to expertise, a consultant should have a track
record of past accomplishments. Individuals with higher levels of education and experience will
generally receive greater compensation for their services. Consulting is a broad area of interest,
and, from businesses to personal services, there's a consulting opportunity for practically every
industry.

Financial consultants counsel clients on investment opportunities and this requires

staying up to the minute with fluctuations in the market. They have to be excellent salespersons,
selling themselves, their firms, and their investment ideas. Some financial consultants serve only
individuals while others serve only businesses such as retail chains or institutions.

Qualifications:

• Must have at least a bachelor’s degree from an accredited educational institution.

• Master’s in Business Administration (MBA)
 • Must pass and possess the General Securities Representative License, also known as the
Series 7
• Must further establish their credibility by getting a certification. Certifications are not
required but are encouraged by brokerage firms. (certified financial planner)
• Must have real world experience, preferably in a business or sales setting. Interpersonal
sales skills and communication skills.

Investment consultants help

clients plan their investments and
assess any risks associated with
making specific investments. These
consultants will monitor several
investments at a time to determine
how well they are working toward
meeting clients' goals.

ALTERNATIVES
Michael can consider these following financial intermediaries as his alternatives upon investing
his savings as a nominal investment.

1. Banks: The central and commercial banks are the most well-known financial intermediaries
simplifying the lending and borrowing process along with providing various other services to
its customers on a large scale.
 Basic Savings Account- A savings account is the simplest way to invest money in the
bank. You deposit a certain amount, and the bank pays you interest on that amount. The
interest rates paid out on savings accounts are low, but with most savings accounts you
can access your funds at any time. The bank uses your money to loan out to borrowers at
a higher interest rate, enabling them to provide funds and make profit while essentially
sharing that profit with you.
 IRA- An Individual Retirement Account (IRA) is a way to save money and avoid taxes
while investing. You can set up an IRA account through your bank. Most offer a choice of
various mutual funds, stocks and bonds as the means of saving.
 529 College Savings Plan- A 529 College Savings Plan allows you to set up an account
for your child’s higher-education costs. You pay no taxes on the account’s earnings, there
are no income limitations, and most have no age limits on when the savings can be used.
If the particular child chooses not to go to college, the account can be deferred to another
family member. If the child gets a scholarship and doesn’t need all the money for college
costs, the excess can be withdrawn without paying additional penalties. It’s a good way to
ensure your child can afford college and to invest in your bank in the meantime.
 Certificate of Deposits- One of the most popular choices for investing in the bank, a
certificate of deposit (CD) is basically a closed savings account. You put money in, and
you cannot access it (without a penalty) for a certain amount of time. There are 5-year
and 10-year cds, and the interest rate on a CD is significantly higher than it would be on a
regular savings account. At the end of the term for the CD, you can either withdraw your
money or re-invest it.
 Index Fund- An index fund is one of the safest ways to invest money in the stock
market. Investing in an index fund and using your bank as the broker gives them the
opportunity to get the commission of your purchases and sales, rather than paying those
to an individual broker or brokerage firm.

2. Credit Unions: These are the cooperative financial units which facilitate lending and
borrowing of funds to provide financial assistance to its members. On the surface, credit
unions look a lot like banks. They both hold deposits, make loans, issue checks
and ATM cards, and offer investment services. But the real difference between banks and
 credit unions has less to do with the services they offer and more with how each institution is
run. Banks are for-profit companies. They make money by charging interest on loans,
collecting account fees and reinvesting all that money to earn more profit. But as for-profit
companies, they also pay state and federal taxes. Credit unions, on the other hand, are not-
for-profit institutions. Technically, credit unions are owned by their account holders, known
as members. Any profit earned by a credit union is either invested back into the organization
or paid out to members as a dividend [source: Federal Reserve]. As a not-for-profit
institution, credit unions pay no state or federal taxes, meaning they can charge lower interest
rates than banks for most financial services.
3. Non-Banking Finance Companies: A NBFC is a financial company engaged in activities
such as advancing loans to its clients at a very high rate of interest. It is that financial
institution which provides the banking services to the customers without having a banking
license. An NBFC needs to be compulsorily registered under the Companies Act 1956
however it can be owned privately or by the government.
4. Stock Exchanges: The stock exchange facilitates the trading of securities and stocks, and in
every trading activity it charges the brokerage from each party which is its profit.
5. Mutual Fund Companies: The mutual fund organizations club the amount collected from
various investors who have the same investment objective and risk-taking ability, to invest in
the securities, bonds and other investment options to ensure a capital gain in the long run.
6. Insurance Companies: These companies provide insurance policies to the individuals
and business entities to secure them against accident, death, risk, uncertainties and default.
For this purpose, they accept deposits in the form of premium which is pooled into profitable
investments to gain returns. The insured person can claim the money in case of any mishap as
per the agreement.
7. Financial Advisers or Brokers: The investment brokers also collect the funds from various
investors to invest it in the securities, bonds, equities, etc. The financial advisers even
provide guidance and expert opinions to the investors.
8. Investment Bankers: These banks specialize in services initial public offerings (IPO), other
equity offerings, proving for mergers and acquisitions, institutional client’s broker services,
underwriting debts, etc. while mediating between the investor or public and the companies
issuing securities.
9. Escrow Companies: It is a third party acting as an intermediary and responsible for getting
all the conditions fulfilled at the time of loan provided by one party to the other for the real
estate mortgage.
10. Pension Funds: The government entities initiate a pension fund where a certain amount is
deducted from the salary of the employees each month to be returned with interest after their
retirement. This collected sum is then invested in different schemes to gain profits.
11. Building Societies: These financial intermediaries are similar to the credit unions, owned
and facilitating mortgage loans and demand deposits to its members.
12. Collective Investment Schemes: Under this scheme, the various investors with common
investment objective come together to pool their funds and collectively invest this amount
into a profitable investment option. Later they distribute the interest among themselves as per
the agreement.

PROPOSED SOLUTION

As a financial consultant, it is their responsibility to make their client understand first

what a stock market is. They should explain how does it works and what are the possible results
that they could get upon entering to it. Afterwards, they could now introduce to their client the
appropriate financial market or financial intermediary that they could have entered based on their
financial status and according to what they prefer and is willing to risk.

The stock market is where shares of ownership of different companies are bought and
sold. These markets provide a secure and regulated environment where market participants can
transact in shares and other financial instruments with zero-to low-operational risk. There are
two ways in earning money on stocks that are invested in these markets, (1) through appreciation
of stocks, and (2) through dividends declared.

The first step to do before you invest, is to study your own profile as an investor to know
how much you can invest. Second is to decide how much you are going to invest, stock market
allows investors to invest with just five thousand pesos with some stock brokers, but the more
funds you have the better you can diversify your holdings to minimize risk. Third step is to open
an account with a reputable stock broker, then decide what stock to pick and lastly, place an
order. Once your order is completed, your stock broker will give you a confirmation invoice
indicating the details of the transaction.

Aside from investing in a stock market to pursuit higher gains, Michael may put up his
savings or funds in Asset Management Firms which primary objective is to maximize return
from investments in various financial instruments to add value for the investors. Asset
Management Firms manage funds owned by individuals, companies or the government through
buying and selling of financial instruments. The role of these Asset Management Companies is to
take investor capital and put it to work in different investments like stocks, bonds, real estate,
master limited partnerships, private equity, and more.