investment instruments mr chong kek weng. moneysmart personal finance 082 outline 1. money market...

Investment Instruments

Mr Chong Kek Weng

MoneySMART Personal Finance 08 2

Outline

1. Money Market Instruments

2. Capital Market Instruments

Fixed deposits Treasury bills Money market funds

SharesInvestment TrustsExchange Traded FundsWarrantsBondsStructured Deposits

Inflationary Risks


Short-term securities that mature in one year or less from their issue date (3 -12 months)

Bought and sold at a price less than face (par) value

Maturity proceeds - amount of S$ equivalent to the face value of the security

Interest earned on the T-bill is the difference between the purchase price of the security and its face (par) value

Treasury Bills


Money Market Funds

Unit Trusts which invest in ST instruments

SIBID or SIBOR

Distributors - dollardex, fundsupermart etc


Capital Market instruments

Shares

Investment Trusts

Exchange Traded Funds

Warrants

Bonds

Structured Deposits


Ordinary shares traded in lots of 1000 shares

Smaller denominations (100, 200 shares)

Growth, Defensive, Blue Chip, Cyclical

Price appreciation

Dividend

Shares

STI Index – Mar 07 to Mar 08

3875

3467

28372836 (1 Dec 06)

10%

27%


Real Estate Investment Trusts (REITs)

Business Trusts

REITs are property funds that invest in real estate assets such as commercial, industrial, retail, hospitality, logistics and residential properties

Launch of Singapore's first listed Real Estate Investment Trust (REITs) in July 2002

CapitaMall Trust, Ascendas, Fortune REIT etc

Investment Trusts


10 Mar 08

REITs31 Jan 08

REITs - Yields


Business trusts - business enterprises set up as a trust structure, as opposed to a corporate structure. hybrid structures with elements of both companies and trusts.

Not focused on real estate assets and are suited for businesses with stable growth and cash flow, such as infrastructure or utilities, vehicle leases, charter businesses

Babcock & Brown, CitySpring, Shipping Trusts

Investment Trusts


The income of REITS and business trusts are pooled and distributed pro rata to the unit holders of the trust

Appeal to investors looking for investments that are backed by assets and that provide returns mainly in the form of a regular payout rather than capital gains

Investment Trusts


REITS and business trusts subject to market fluctuations

The unit price of a REIT or business trust depends on many factors and may go down if underlying assets drop in value

Projected dividend distributions may not be achieved if the income of the REIT or business trust is lower than expected

Investment Trusts Risks


Open ended investment funds listed and tradedon a stock exchange like stocks

As investors buy and sell an ETF, market maker can create new units or cancel units to meet market demand and ensure ETF price in line with the net asset value of the ETF

Possible because ETFs open ended investment funds with creation and redemption features

Aim to track the performance of an index and provide access to a wide variety of markets and asset classes

Exchange Traded Funds (ETFs)


SGX Xtranet created to list and trade structured products such as ETFs

Initial 6 ETFs S&P 500 SPDRs®, iSharesSM S&P 500 Index Fund, DJIA DIAMONDS®, iShares Dow Jones U.S. Technology Sector Index Fund, iSharesSM MSCI Singapore Index Fund and streetTRACKSSM Straits Times Index Fund

ETFs


ETFs similar to unit trusts

Allow for diversification and professional management

Diversified Portfolio – can invest 100% of CPF funds compared to 35% in individual stocks

Low Cost Less than 1% annual management fees and usual stock broking commissionAnnual management fees of only 0.3% for StreetsTRACK STIEmploy a passive indexing strategy

ETFs - Advantages


Tradeability – buy and sell like stocks

Transparency – closely mirrors underlying index of which components are disclosed on daily basis

Efficiency - No need to stock pick

ETFs - Advantages


Prices as at 31 Jan 08

ETFs


ETFs - RISKS

Market riskmarket risk or volatility of the specific benchmark which the ETF tracks. e,g, performance of the iShares MSCI India ETF directly affected by the price fluctuations of constituent stocks within the MSCI India Index

Tracking errorFund manager of ETF may not be able to exactly replicate the performance of the specific benchmark due to management fees, timing differences and other factors


Foreign exchange riskETFs denominated in foreign currencies, foreign exchange rate fluctuations may affect the returns

LiquidityRisks arising from difficulty in buying or selling an ETF. Liquidity provided by market maker who put up continuous bid/ask prices throughout the trading day.

ETFs - RISKS

“the best way to own common stocks is through an index fund...“ Warren Buffet


gives the owner/investor the right but not the obligation to buy/sell the underlying asset at a pre-determined price on (or before) a pre-determined date

Underlying asset can be a stock, index, currency, commodity etc

Warrants


Warrants - Characteristics

Right but not the obligation

Value is affected by the underlying asset’s price

Longer maturity means a higher warrant value

More volatile the underlying price, the higher the price of the warrant


Issued by listed company

they are exercised for shares at a pre-determined price (exercise or strike price) that is paid on exercise

Warrants have a fixed tenure called the exercise period and, if not exercised, are worthless after their expiry date

Equity warrants


Value of Equity Warrants

The value of the warrant may be dependent on a number of factors. The two important ones are

–the exercise price of the warrant, and

–the current market price of the shares

Equity warrants


Qian Wu Corp Ltd W100919

Qian Wu Warrant Maturity

Conversion Ratio : 1

Exercise Price : $0.035

Current Warrant Price : $0.12

Current Share price : $0.16

*Prices as at 26 Nov 07

Equity warrants

Qian Hu Warrants - info


Not issued by the listed companies but by third parties

Third parties normally banks, stock broking firms etc

Settlement is by cash and not delivery of shares

SEMCORP INDUS SGA ECW 080303

03/03/08

SemCorp Industries Societe Gen European Call Warrant

Covered or Structured Warrants

MoneySMART Personal Finance Nov07

29

As at 26 Nov 07


Price dependent on “underlying” share, exercise price, volatility of share price and expiry date

Buyer of call warrants expect price to rise (bullish) whilst buying of a put is a hedge against potential price fall. (bearish)

Call and Put warrants


31

Loss Zone

Profit Zone

Payout Profile of a Call Warrant

Price of theUnderlying Asset

Payoff

Call Premium

Strike Price

0

Payoff Function for Buyer of a Call Option

45o

Los

sP

rofi

t ?


Payoff

Call Premium

Strike Price

0

Payoff Function for Buyer of a Call Option

45o45o

Los

sP

rofi

t ?

Breakeven price


32


Payoff

Put Premium

Strike Price

0

Payoff Function Buyer of a Put

Option

45o

←Lo

ssPr

ofit

→


Payoff

Put Premium

Strike Price

0

Payoff Function Buyer of a Put

Option

45o45o

←Lo

ssPr

ofit

→

Loss Zone

Profit Zone

BreakevenPrice

Payout Profile of a Put Warrant


Value of warrants?

The intrinsic value of the warrant is the difference between

exercise price of a warrant

market price of the underlying shares.

Warrants


in-the-money if the market price of the underlying share is above the exercise price of the warrant.

out-of-the-money if the market price of the underlying share is below the exercise price of the warrant.

at-the-money when the market price of the underlying equals the exercise price of the warrant.

CALL warrant


Time Decay to Expiration Time Value

90 days 60 days 30 days 0 dayRemaining Lifetime

Warrant - life

A quick ending time decay is low at the beginning of the warrant lifetime but accelerates towards expiration


Other FactorsDays to Maturity - > the higher the warrant

Implied volatility – market expectations for volatility of the underlying within a future period of time. Positive relationship

Interest Rate – represents opportunity cost that can be saved by investing in a warrant.

Dividends – when dividends increase more than expected, price falls on ex- dividend date

Conversion Ratio – higher, lower the warrant price

Warrant - value


Structured warrants vs Stocks

Limited/small investment amountTime constraint - expiration

John Jim

Purchase 1000 shares of UOB 1000 UOB warrants

Buys $14.50 $0.20

Sells $15.20 $0.30

Gain $700 $100

Return or gain 4.83% (700/14500) 50% (100/200)

Gearing - Leverage double edged and works both ways

Unlimited upside/ limited downside

Can protect the value of your assets


Warrants - Risks

• Liquidity• Market• Default on market making obligation• Limited life of warrants• Extraordinary event

“Warrants, options and all derivatives are zero-sum, which make them more like gambling than investing.” Dr Money


1. Understand warrant characteristics

2. Identify market direction and choose right investment product

3. Determine the investment horizon

Warrants - Investment Tips

4. Choice of warrants

5. Consider implied volatility


Put in stop loss - under all circumstances investors should make it a discipline to stop loss

Buying more to average out is never a good idea as it means assuming greater risks.

Time decay working against you

If underlying keeps falling, warrants may go from ITM to ATM and OTM. For a warrant deep OTM and about to expire, relatively insensitive to movement of underlying

Warrants - Investment Tips

Others – Zero Strike Participation Certificates


Most common and carries a fixed interest rate and repayable at maturity at the redemption price fixed at the date of issue

Redemption price usually fixed at par and interest payable semi-annually or annually

Attraction of bond depends on reputation, coupon rate, currency, interest rate prevailing in the market

Bonds


Bonds are debt securities that pay a fixed rate of interest (called the coupon), usually every six months, for the life of the securities and then their face (par) values on redemption on maturity

SGS bonds are issued with maturities of 2, 5, 7, 10 and 15 years.

The minimum denomination of both SGS T-bills and bonds is S$1000. Can use CPF funds

Singapore Government Securities


First, approach any participating bank i.e. a Primary Dealer or Secondary Dealer of the SGS market to open a SGS trading account

Purchase SGS over the counter with these banks

Scripless, ownership of SGS reflected as a book entry in the investor's account with the bank

Primary auctions, need to open accounts with and submit your bids through the Primary Dealers or through any Secondary Dealers who will submit bids

SGS Purchases


Riskless security, negligible Credit default risk

Inverse relationship to interest rate movements

Price and market risk

Liquidity of issues

SGS - Considerations


A combination of a deposit and an investment product, where return dependent on the performance of some underlying financial instrument

Typical financial instruments linked to such deposits include market indices, equities, interest rates, fixed-income instruments, foreign exchange or a combination of any

STRUCTURED DEPOSIT


DBS Pinnacle Notes Series 1-7 @

BNP Star Select

STRUCTURED DEPOSITs

Deutsche Bank Double Chance Certificates

May Bank Regal Structured Deposit

Rabobank – Rabo Jet Series 1,2,3


Type of Structured Deposit

Description Risks Involved

Equity or Bond-linked

Equity-linked deposits are linked to stocks, or a basket of stocks, as determined by the issuer.

Equity-linked deposits may also be linked to an equity index (for example, the S&P 500) or a group of indices.

Bond-linked deposits are linked to bonds (for example, Singapore Government Securities).

Returns are dependent on the performance of the equities/bond market. Exposed to the risk that the markets do not move in the direction you anticipated.

Exposed also to the risk that the issuer of the bonds or stocks becomes insolvent. If this happens, your returns may be zero.

Issuer may cap returns, or may exercise its right to cap returns if the equities/bond market perform far beyond expectations. With returns capped, you bear the opportunity cost of potentially higher returns had you invested directly in the equities or bonds


Interest rates-linked

Returns are usually linked to a formula that makes reference to a specific floating interest rate (for example, the Singapore Interbank Offer Rate).

The formulas used for such deposits may display a number of characteristics. Instead of being directly related to the specified interest rate, your returns may be inversely related i.e. when the specified interest rate falls, you may get better returns. Such products may be called "inverse floaters" or "reverse floaters“.

The payouts on such deposits may also rise or "step up" at pre-determined points in time if the deposit is not redeemed by the issuer.

Returns may depend on the direction in which interest rates move, or the pace at which interest rates change.

Exposed to the risk that interest rates do not move in the direction you anticipated, or the interest rate curve is steeper or more gradual than you had anticipated.




Credit-linked

Unlike other structured deposits, returns on this type of deposit is not linked to the performance of a financial instrument, but rather the occurrence of what is known as a "credit event" (for example, if a specified company becomes insolvent or defaults on its loans).

Returns are entirely exposed to the credit risk of the specified company, or any other party that the issuer has entered into a contract with.

Need to be able to assess the likelihood of a credit event occurring to this party.




Features Structured Deposits S$ Fixed Deposits

Minimum Deposit higher lower

Maturity Variable (2 wks to 10 yr) fixed

Principal Repaid in full upon maturity or redemption

Repaid upon maturity

Early Withdrawal (investor)

Depends on underlying – may lose principal

May incur a penalty – not lose principal

Early Redemption

(issuer)

Possible with call feature or “trigger” when payouts reach a target rate

No such clause

Risks/Returns More risky than FDs but less risky than direct investments. Principal protected. Variable returns pending call, cap, participation rate etc

Low risks/returns


Instrument provides investors fixed income like principal protection together with equity market upside exposure

Limited downside risk but upside potential

Structured by combining the economics of a long call option (10%)on equity with a long discount bond position (90%)

Equity Linked Note (ELN)

Appropriate for conservative equity investors or fixed income investors who desire equity exposure with controlled risk


Profit Diagram of a ELN

Starting Index Level

Return of Principal plusequity upside opportunity ifthe underlying index isabove the starting indexlevel

Return of Principal if underlying index is below the starting index level

70% 75% 80% 85% 90% 95% 100% 105%110%115% 120% Price or Index Level at maturity

60%50%40%30%20%10% 0%-10%-20%-30%

Profit and loss

Bond

Call Option

+ Credit Linked Note

Principal Protection

Equity Participation

54

Banks not forthcoming with information on yearly returns. Min and Max Returns

Focus on hype. Initial large payout – advertising ploy?

May have been simply a return of a portion of your capital

Gains capped and early redemption

Lack of transparency and complex link with basket

No free lunch. Really principal guaranteed? Liquidity?

Structured Deposits

MoneySMART Personal Finance 08


“These products add nothing to retail investors’ portfolios that can’t be acquired from investments “already available in the market in the form of less risky, less complicated, or less costly products” and therefore fail the “reasonable-basis” suitability requirement for sale to retail investors.”Are Structured Products Suitable for Retail Investors? (15 Dec 2006)Craig McCann, PhD, CFA and Dengpan Luo, PhD, CFA

Structured Deposits


Conclusion – Risks v Return

Stocks

Bonds

Deposits

Risk

Return

Money Market Instruments

Structured Deposits


Conclusion

• Determine investment objectives and investment horizon, asset allocation

• Understand risk profile. Be aware of how much you can afford to invest and how much losses you can afford to incur

• Investor education. Understand how the product works before you invest. Do not invest in anything you do not understand or are not comfortable with

• Long term to ride out cycles

investment instruments mr chong kek weng. moneysmart personal finance 082 outline 1. money market...

Documents

moneysmart personal

business trusts subject

money market funds unit

fundsupermart etcetc

money market instruments

open ended investment

market fluctuations

market demand