Post on 24-Dec-2015
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
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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
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Money Market Funds
Unit Trusts which invest in ST instruments
SIBID or SIBOR
Distributors - dollardex, fundsupermart etc
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Capital Market instruments
Shares
Investment Trusts
Exchange Traded Funds
Warrants
Bonds
Structured Deposits
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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%
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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
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10 Mar 08
REITs31 Jan 08
REITs - Yields
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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
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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
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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
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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)
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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
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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
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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
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Prices as at 31 Jan 08
ETFs
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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
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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
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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
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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
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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
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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
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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
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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
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As at 26 Nov 07
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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
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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 ?
Price of theUnderlying Asset
Payoff
Call Premium
Strike Price
0
Payoff Function for Buyer of a Call Option
45o45o
Los
sP
rofi
t ?
Breakeven price
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Price of theUnderlying Asset
Payoff
Put Premium
Strike Price
0
Payoff Function Buyer of a Put
Option
45o
←Lo
ssPr
ofit
→
Price of theUnderlying Asset
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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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Riskless security, negligible Credit default risk
Inverse relationship to interest rate movements
Price and market risk
Liquidity of issues
SGS - Considerations
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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
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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
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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
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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.
Type of Structured Deposit
Description Risks Involved
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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.
Type of Structured Deposit
Description Risks Involved
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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
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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
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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
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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
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“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
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Conclusion – Risks v Return
Stocks
Bonds
Deposits
Risk
Return
Money Market Instruments
Structured Deposits
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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