Identify the nature and key components of financial systems domestically and globally to apply in diverse contexts.
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RMIT Classification: Trusted BAFI1005 Financial Markets and Institutions Assessment 3: Research Report – Case Study Overview This assessment involves a case study covering different financial markets and instruments. Your role as a financial advisor is to craft a comprehensive Investment Strategy Research Report for the client, showcasing your ability to analyse evolving market dynamics and various financial assets, ultimately delivering strategic recommendations. Learning Outcomes The targeted Course Learning Outcomes for this assessment are: • CLO1: Identify the nature and key components of financial systems domestically and globally to apply in diverse contexts. • CLO2: Identify the nature, role, and determinants of the structure and level of interest rates in economics and financial contexts. • CLO3: Analyse the characteristics and functions of the main financial intermediaries and the role of regulatory bodies in financial systems in a global context. • CLO5: Explore the main features and theorems of capital markets, institutions, and securities including debt securities, equity, and derivative products. Assessment details • The assessment is a scenario-based research analysis report. You are required to conduct independent research and write 303000-word-/+10%) report. • This assessment includes all the content covered in Topics 1 to 10. • The assessment is worth a total of 50 marks and accounts for 50% of the total grade for this course. Formatting • The report must be presented in standard report structure. • The report must be presented and submitted in Microsoft Word document. • You may use hand-drawn diagrams where applicable. Include the image of the diagram – use balanced resolution so the information in the image is • Guidelines for text formatting: o Font style: Arial o Font size: 12 (14 for headings) o Spacing: 1.5 line spacing o Page No: Page x
RMIT Classification: Trusted Final Assessment – Research Report Case Study Background: As a financial advisor, you have the responsibility to educate and empower clients with a deep understanding of market and economic systems to remove the mystery and fear associated with investing. This approach fosters confidence and informed decision-making, enabling clients to invest wisely regardless of external economic conditions. Your task is to prepare a comprehensive investment strategy research report for your new client, Mr. Tan. This report should align with Mr. Tan’s client profile, including his wealth, risk preferences, and investment objectives. Report Requirement: Your report should be well-supported with examples and credible sources, including peer-reviewed journal articles, papers, books, industry reports, institutional reports, regulatory standards, and official materials. Do not rely solely on general websites for information. A minimum of 8 references is expected. Detailed instructions for each section: ❖ Executive Summary: Provide a brief summary of the key findings, recommendations, and the client’s profile and objectives. ❖ Introduction: Offer context for the report and its purpose. ❖ Section 1: Market conditions and Monetary Policy • Discuss current market conditions in Singapore and globally that may impact investment decisions. • Discussion differences in the Monetary Policy Implementation Process in Singapore compared to Australia. • Explain the intermediate target for monetary policy set by the MAS and highlight the objectives and tools that the MAS employs to achieve this target. • Offer examples of economic indicators that provide insights into future stages of the business cycle. • Explain how changes in key economic indicators influence the Singapore Economy, referencing the brief of recent Economic Development in Singapore published in August.
RMIT Classification: Trusted ❖ Section 2: Asset Classes Discussion • Based on Mr. Tan’s profile and risk preference, market conditions, and available asset classes, recommend at least four suitable assets for his portfolio. • Discuss the characteristics, risks, potential returns, and provide examples for each asset class. You are encouraged to utilise diagrams, charts, tables and figures in the discussion. • Explain to Mr. Tan regarding pros and cons of the right issue, assuming he owns 1000 Tesha shares and below scenario: In 2023, Tesha, Inc. conducted a rights issue to raise additional capital for its growth and expansion plans. Shareholders were given the opportunity to purchase additional Tesha shares at a discounted price on a ratio of 1:5. Tesha’s stock price before the rights issue announcement was approximately $800 per share. The discount price is $500 per share. Assuming Tesha has 1,000,000 shares and all shareholders exercise their rights. ❖ Section 3: Funds Under Management • Considering Mr. Tan’s preference for cost-effective index funds and his pursuit of promising returns, provide an overview of funds in his portfolio. • Evaluate the historical performance, risk, and return of these funds compared to benchmark indexes. • Address potential overconfidence bias in Mr. Tan and propose a diversified fund selection strategy. • Introduce one or two new funds aligned with Mr. Tan’s needs and your expertise. • Explain fund measurement by calculating the coefficient of variation and Sharpe ratio using the provided data and provide an interpretation of calculations. ❖ Section 4: Hedging Using Derivatives • Discuss the potential use of derivatives (e.g., options or futures) to hedge Mr. Tan’s portfolio against adverse market movements. • Explain the benefits and risks associated with derivatives-based hedging strategies. • Assess the alignment of these strategies with Mr. Tan’s risk tolerance and overall investment plan. ❖ Conclusions: Summarize key takeaways from the report. Emphasise the importance of informed decision-making in achieving Mr. Tan’s investment objectives. ❖ Reference List: Follow the RMIT Harvard referencing style for all citations and references.
RMIT Classification: Trusted Appendix: Appendix. 1 Client Profile: Mr. Tan, 35 years old, BA (Law), MA (Law), Juris Doctor, Barrister at Slater and Gordon Singapore. Mr. Tan specialises in corporate law and has some understanding of finance but cannot be considered a sophisticated investor in the financial markets. Mr. Tan’s assets are estimated at 5 million Singapore dollars. He is willing to take a reasonable amount of risk, and his primary objective is to achieve portfolio appreciation over time. For this, he is prepared to accept an elevated level of portfolio volatility and the risk of principal loss. His investment time horizon is 3 to 5 years. Mr. Tan is cost-conscious and prefers cost-effective investment management solutions such as index funds for his portfolio. However, he expects you to carefully select the most promising funds and create a successful investment strategy. Mr. Tan is initially looking to invest 2 million Singapore Dollars in your recommended funds. You suspect the client may have overconfidence bias and home bias. Appendix. 2 Fund List: Current Funds/Managers list: Asset Class Fund details Debt Management Company State Street Global Advisors Strategy Name State Street Singapore Bond Fund Benchmark Singapore Government Securities (SGS) Index Singaporean Equity Management Company BlackRock Strategy Name iShares MSCI Singapore ETF Benchmark MSCI Singapore Index Emerging Equity World Management Company AMP Superannuation Limited Strategy Name AMP – Lazard Emerging Markets Equity Fund Benchmark The MSCI Emerging Markets Index Absolut returns & Alternative Assets Management Company BetaShares Capital Limited Strategy Name BetaShares Crude Oil Idx ETF-Currency Hgd Benchmark S&P GSCI Energy Index Total Return Appendix 3. Excel Data File
RMIT Classification: Trusted Referencing guidelines Use RMIT Harvard referencing style for this assessment. You must acknowledge all the courses of information you have used in your assessments. Refer to the RMIT Easy Cite referencing tool to see examples and tips on how to reference in the appropriated style. You can also refer to the library referencing page for more tools such as EndNote, referencing tutorials and referencing guides for printing.
Question 1a)
The financial assets suitable for Daniel would be derivatives, hybrid financial assets and equity financial assets. Derivatives are financial assets that are derived from another financial asset, rate or index and are designed to manage specific risk exposures. It is a variation in the value of the underlying asset that will result in a variation in the value of derivatives. An example of a derivative is options.
Characteristics:
They can be traded over the counter or via an exchange
They can be categorised under direct and indirect finance
Derivatives markets are generally wholesale markets
High Risk:
Derivatives involve counterparty risk as it is possible for the other party in the agreement to default, especially trading over the counter (Forbes 2021)
Potential returns:
The potential returns could be high if investors use derivatives for speculation purposes to increase the level of risk in return for profits
Hybrid financial assets are financial assets that possess features of both debt and equity. An example of it is convertible notes.
Characteristics:
Possess features of pure equities and pure bonds (CFI 2023)
Relatively lower risk than pure variable income securities (CFI 2023)
Potentially greater return than pure fixed income securities but lower return than pure variable income securities (CFI 2023)
High risk:
They have a higher risk than bonds or stocks, due to lower liquidity than a stock, and greater market exposure than a bond (Yahoo Finance 2020)
Potential returns:
Higher return due to the involvement of both debt and equity (Yahoo Finance 2020)
Equity financial assets are representative of an ownership claim over the profits and assets of a business. An example of it is ordinary shares.
Characteristics:
Carry voting rights
The value of equity securities can be influenced by factors including industry events, organisation’s financial performance and investors’ sentiments
High Risk:
High risk as the business is exposed to various factors including macroeconomic and industry risk, which has the likelihood of leading to significant losses.
Potential returns:
Has high potential return if the business is profitable and increases its value over time and gives out dividends to shareholders.
Question 1b)
The role of a drawer, in this case, is DBS bank. It is the creator of the bill, aiming to borrow money from the discounter, who are the corporate clients.
The role of an acceptor helps to guarantee the bank bill. Acceptor charges DBS a fee for being the acceptor. If DBS is unable to pay the bill amount to the discounter, the acceptor will have to pay on DBS’ behalf.
The role of a discounter, which is also the lender, purchases the bill from the drawer. Once the maturity date is up, the discounter presents the matured bill to the acceptor and collects the full amount.
Question 1c)
Renounceable rights issue of ordinary shares can be sold separately from the shares in the secondary market and exercised by the buyer. It is a method of raising capital for the business from existing shareholders. The advantages of it are that it could be a quick method for raising capital for the firm and more cost effective as there is no debt involved in the process, since they are all equity. The disadvantages include the dilution of stock ownership and potentially a drop in share price.
Dilution is a fall in shareholders’ ownership percentage due to the issuance of additional shares (AccountingTools 2022). One potential reason for the drop in share price as a result of dilution could be the increasing supply of shares that leads to a fall in demand, therefore, a drop in share price.
Question 2a)
Singapore adopts the exchange rate as its intermediate target of monetary policy, utilizing a path for the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) to ensure medium-term price stability as the ultimate objective of its monetary policy. (MAS n.d.).
The implementation process of the monetary policy in Singapore involves the Monetary and Domestic Market Management Department (MDD) (MAS n.d.). MDD relies on spot foreign exchange (FX) market intervention operations as its primary means of managing the S$NEER (MAS n.d.). To maintain the S$NEER within the policy band and ensure domestic price stability, MDD conducts FX intervention operations by selling or purchasing USD in exchange for SGD (MAS n.d.). While implementing the monetary policy, MAS increases its Official Foreign Reserves, which results in changes in the size of its balance sheet (MAS n.d.). MAS’ intervention operations are therefore similar to interest rate-targeting central banks’ monetary policy operations (MAS n.d.). As a result of monetary policy operations, the central bank’s balance sheet changes under both exchange rate and interest rate regimes (MAS n.d.). This demonstrates the credibility of MAS in formulating monetary policy that is consistent with the economic outlook and the objective of maintaining medium-term price stability (MAS n.d.)
Examples of different economic indicators that could offer insights into future stages of a business cycle include Gross Domestic Product (GDP), unemployment rate, and Consumer Price Index (CPI).
Question 2b)
Rising interest rates increase the demand for AUD as it attracts more investment to the country. At the same time, it decreases the supply of AUD as rising interest rates discourage capital outflow. With that, the AUD will appreciate. This is further supported by Graph 1. When AUD appreciates, Australia’s exports decrease due to the increase cost of goods for foreign buyers. On the other hand, imports will increase as foreign goods become relatively cheaper due to the strengthening of AUD. For example, the rising cash rates would result in Australia importing more foreign cars, as the currency has grown stronger, therefore foreign cars become relatively cheaper. However, the rising cash rates would lead to lower exports such as agricultural products as it has become relatively more expensive to foreign purchasers.
Graph 1:
Question 2c)
Based on the graphs generated for treasury bill and government bond, they suggest that long-term interest rates are greater than short-term ones. Under expectation plus liquidity premium, investors are indifferent between short and long-term investment, but they require a liquidity premium to compensate for the greater risk associated with long-term investments. Therefore, the shape of the yield curve would be a normal curve, where the long-term yield is greater than the short-term yield. With these insights, I believe that the Australian economy is heading toward a boom as a normal yield shape curve typically expects strong economic growth.
Question 3a)
For instance, the Qantas airline manager intends to enter a futures contract to lock the price of fuel. The current price of fuel is $2 per gallon, and the manager enters a futures contract to buy 20,000 gallons of fuel in 2 months’ time. 2 months later, the price of fuel per gallon reached $2.50, and the manager is able to purchase it at $2 per gallon with the futures contract. Therefore, the manager successfully mitigated the price increase of fuel.
On the other hand, if the price of fuel per gallon falls to $1.80 in 2 months’ time, the manager is still obliged to purchase the fuel at $2 per gallon due to the futures contract. This resulted in a loss of $0.20 per gallon of fuel. Despite the loss, the airline is certain about the price that it had to pay, and therefore, reduce risk exposures.
Question 3bi)
Question 3bii)
Daniel is facing systematic risk as Amazon’s shares dropped as a result of the volatile nature of the stock market. Systematic risk is a critical and relevant risk as it is related to market factors that impact every firm and cannot be eliminated via diversification. It is suggested for Daniel to select put option with a strike price of $145. In the event that the stock market drops further, Daniel is able to exercise his rights to sell the option at $145 to hedge risk and reduce further losses.
Question 4a)
The purpose of capital stable funds is to offer a moderate level of income with some capital growth by investing in a variety of asset classes but with a significant portion in defensive assets including cash and fixed interest investment; and a marginal portion in growth assets like properties and shares (Moneysmart n.d.). The funds primarily safeguard their contributions by investing in securities with low-risk and return securities.
The purpose of balanced growth funds seeks to invest in longer-term income streams supported by limited capital growth, and they include domestic and foreign equities. Balanced growth funds typically accumulate stocks and bonds (trsnyc n.d.).
The purpose of managed capital growth funds aims to invest for a higher return via capital growth and less through income streams, the investments accumulate a greater portion of foreign and domestic equities.
As a result, it is recommended that Jay invests in a capital stable fund because it has the lowest risk profile among the three funds, mainly due to its primary focus on low-risk securities.
Question 4b)
Coefficient of variation CV = σp ∕ Rp
Coefficient of Variance for Fund A = = 1.03150 ≈1.03 (2d.p.)
Coefficient of Variance for Fund B = = 1.15420 ≈1.15 (2d.p.)
Coefficient of Variance for Fund C = = 1.03632 ≈1.04 (2d.p.)
Fund B has the highest Coefficient of Variance among the three funds. This indicates that it is the riskiest fund as compared to Fund A and C, since their coefficient of variance is of similar value.
Sharpe Index SI = (Rp − Rf) ∕ σp
Sharpe Index for Fund A = = 0.61113 ≈0.61 (2d.p.)
Sharpe Index for Fund B = = 0.48085 ≈0.48 (2d.p.)
Sharpe Index for Fund C = = 0.51958 ≈0.52 (2d.p.)
Fund A generates the highest Sharpe index based on the risk-free rate per unit of standard deviation among Fund B and C, indicating the greatest efficiency in producing the highest return for each unit of risk taken.
Jensen Index (alpha) α = (Rp − Rf) − βp (Rm − Rf)
Jensen Index for Fund A = (9.74-3.60) – 0.82(6.65-3.60) = 3.639
Jensen Index for Fund B = (8.09-3.60) – 1.22(6.65-3.60) = 0.769
Jensen Index for Fund C = (7.80-3.60) – 0.95(6.65-3.60) = 1.3025
Fund A generates the highest Jensen Index based on its systematic risk, indicating that the portfolio manager for Fund A has the ability to generate the highest return given the level of risk among the three funds.
Question 4c)
Colonial First State Developing Companies Fund possesses a higher risk than Vanguard Australian Shares High Yield Fund as the asset classes are primarily small to mid-growth Australian equities and the asset classes are highly concentrated, with a very marginal percentage in other areas besides Australian Equities (Eureka Report n.d.). Furthermore, small to medium companies usually carry more risk and is more volatile. On the other hand, Vanguard Australian Shares High Yield Fund carries a diversified portfolio of securities, indicating that the Fund has lower exposure to the performance fluctuations of individual securities (Vanguard n.d.), thus, lower risk. Therefore, risk-adverse investors would favour Vanguard Australian Shares High Yield Fund as it has a diversified portfolio with lower risk. Risk-seeking investors would favour Colonial First State Developing Companies as it has highly concentrated portfolio, hence, higher risk.
References
Accounting Tools (2022) Dilution Definition, Accounting Tools website, accessed 22 April 2023.
Birken, Schmidt and Curry (2021) A basic guide to financial derivatives, Forbes Advisor website, accessed 21 April 2023. .
Corporate Finance Institute (CFI) Hybrid securities, CFI website, accessed 21 April 2023.
Eureka Report (n.d.) Colonial Developing Companies – Managed Fund, Eureka Report website, accessed 23 April 2023.
Monetary Authority of Singapore (MAS) (n.d.) What is MAS’ monetary policy framework and its rationale?, MAS website, accessed 22 April 2023. .
Monetary Authority of Singapore (MAS) (n.d.) How does MAS carry out its monetary policy?, MAS website, accessed 22 April 2023.
Money Smart (n.d.) Capital stable fund, Money Smart website, accessed 23 April 2023. .
Reed (2020) Hybrid securities: definition and examples, Yahoo Finance website, accessed 21 April 2023.
Vanguard (n.d.) Vanguard Australian Shares High Yield Fund, Vanguard website, accessed 23 April 2023.
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