What is the difference between commercial papers and certificate of deposits?

Commercial Papers:

Commercial papers refer to short-term unsecured promissory notes issued by a corporation. Like Treasury bills, commercial papers are discounted money market instruments.

Certificate of Deposit

A certificate of deposit (CD) is a certificate issued by a bank in exchange for a  deposit of funds placed with the bank. Yields on CDs are quoted on an interest-bearing basis.

What is the difference between option and warrant?

An option gives the buyer the right to buy (call option) or to sell (put option) a specific amount of an underlying asset within a specific period at a specific price.
A warrant is a right to buy a given number of shares from the issuing company at a specified priced over a given time period (usually over a number of years)

What are the different participants in financial markets?

Participants in financial markets include:
• Investors – retail investors, private bank investors, institutional investors including fund management companies)
• Issuers – public and private sector companies
• Intermediaries –broker/dealer firms and market makers
• Regulators
• Electronic exchanges – for equities, debt, derivatives, and commodities
• Infrastructure providers – clearing house, central depositary, communications networks, trade repositories
• Financial institutions in distributing and underwriting initial public offerings (IPOs), and in maintaining the secondary markets

How a bid-offer spread can help in evaluating the quality of financial market?

Bid-offer spread. This is the spread between the bid and offer price for a security. In efficient markets, this spread is very fine because it reflects wide and deep market-making activities where market makers readily quote two-way prices. Liquid and efficient financial markets usually have reliable market makers, resulting in narrow bid-offer spreads.

What is indicated by the variability of the operating profit margin over time?

The variability of the operating profit margin over time is an indicator of the firm’s business risk. Business risk is the uncertainty of income that is caused by the firm’s industry. In turn, this uncertainty is due to the firm’s variability of sales due to its products, customers, and the way it produces its products.

What are the four basic components to determine the GDP?

To determine the GDP, four basic components need to be considered, namely:
i. Consumption expenditures of individuals on goods and services;
ii. Private investments in capital goods, which consist of capital expenditures for replacement of equipment and for expansion in the supply of capital assets;
iii. Government spending that includes both investment and consumption services. Education, defense, infrastructure development and health services are included in the government component; and
iv. Net exports i.e. total exports less total imports. Net exports may be either positive or negative. When the country sells more to foreigners than they buy, net exports will be positive.

What are the different reasons of money supply coming from external sources?

Money supply can also come from external sources for the following reasons:
1. Funds seeking higher yields (carry trade transactions that seek to earn the interest differential between a low interest currency, e.g. US Dollars and a higher interest rate currency e.g. Indonesian Rupiah). This is sometimes referred to as “hot money”;
2. Funds seeking higher stock market returns in emerging markets and sometimes frontier markets; or
3. Funds seeking higher quality of credit, also referred to as “flight to quality”. This happened in the 3rd quarter of 2013, when Asian markets were trounced because of the announcement of the QE taper, which led to funds flowing out of Asia back to the US and Europe.

What are the different stages of development of an industry?

Over time, the development of an industry can be divided into five stages:
• Early development
• Rapid expansion
• Mature growth
• Stabilisation and market maturity
• Deceleration of growth and decline

What are the five Porter’s competitive forces that determine industry profitability?

According to Porter, there are 5 basic competitive forces that determine the industry profitability:
• Rivalry among existing competitors
• Threat of new entrants
• Threat of substitute products
• Bargaining power of buyers
• Bargaining power of suppliers

How the threat of substitute products affect the profitability of the industry?

Threat of substitute products. Substitute products limit the profit potential of an industry because they limit the prices that firms can charge. Although almost everything has a substitute, one must determine how close the substitute is in price and function to the product in the industry. As an example, the threat of substitute glass containers adversely affected the metal container industry. Glass containers kept declining in price, forcing metal container prices and profits down.

What are the assumptions under the technical analysis?

The assumptions underlying technical analysis are:
i. A security’s market value is determined only by its supply and demand;
ii. Supply and demand is affected by both rational and irrational factors. These factors include not only economic variables employed by the fundamental  analysts but also hopes, fears, opinions, moods and guesses of numerous potential buyers and sellers. The market weighs all these factors automatically and continually;
iii. Prices of individual securities and the overall market move in trends, which tend to persist over an appreciable length of time;
iv. Trends develop in reaction to changes in the supply-demand balance. Such changes can be detected in the action of the market itself; and
v. Chart patterns tend to repeat themselves.

What are the three movements in the market under the Dow Theory?

The Dow Theory postulates 3 movements in the market: the primary movement, the secondary movement, and the daily fluctuations. The primary movement is the market trend, which lasts from several months to several years. The trend is either bullish (up) or bearish (down). Historically, bear markets last for a shorter period of time than bull markets. The Dow Theory attempts to determine the primary movement in the market. The secondary movement of the market is shorter in duration than the primary movement, and opposite in direction. The secondary movement usually lasts from several weeks to months, and usually retraces one-third to two-thirds of the previous advance (decline) in a bull (bear). Day-to-day fluctuations are considered random and have no forecasting value for long-term investors. In Dow Theory, these are not considered to have any impact on long-term price trends.

How consolidation rectangle is formed and what it shows?

A consolidation rectangle is formed when prices move sideways within a arrow range for an extended period of time. It is usually a continuation pattern. A breakout from the consolidation rectangle would be technically significant with a break upwards indicating a bullish trend and a break downwards  signaling further weakness. During the formation of the rectangle, it is difficult to predict which way the price will ultimately break. Therefore, it is assumed that the prevailing trend will continue until proven otherwise.

What elements are included in the portfolio management process for individual investors?

The portfolio management process for individual investors is a dynamic, continuous and systematic one with the following elements:
a. Setting investment objectives. The investor’s objectives, requirements, preferences and constraints are analyzed. The aim is to define a level of acceptable risk that the investor can take and the expected return that is reasonable for that level of risk.
b. Developing and implementing strategies. This involves setting guidelines to determine the allocation of assets and defining under what circumstances and by what means this allocation may vary.
c. Monitoring market conditions. Market conditions and shifting relative values of various asset classes and securities in the market place are closely monitored. In addition, the investor’s needs, circumstances and objectives are evaluated periodically.
d. Reviewing and adjusting the portfolio. Portfolios adjustments are made at appropriate times to reflect changes in the market or the investor’s requirements.
e. Measuring investment portfolio performance. This step involves measuring the performance of the portfolio and then evaluating that performance relative to a benchmark.

What are the practical implications of systematic and non systematic risk for an equity investor?

These two investment risks have practical implications for the equity investor:
• Systematic risk cannot be diversified away and thus there is little the investor can do to protect himself against such risk (other than to stay out of the market); and
• Firm-specific or nonsystematic risk, on the other hand, can be reduced by having a diversified portfolio of shares as individual shares face risks peculiar to themselves. The larger the number of shares in the portfolio, the lower the overall portfolio level of specific risk the investor is exposed to i.e. the greater the diversification of specific risks.

What are the assumptions of CAPM model?

The CAPM is based on the following assumptions:
i. Investors evaluate portfolios on the basis of risk and return.
ii. Investors are rational investors who want to maximize return for a given level of risk and minimise risk for a given level of return.
iii. Individual assets are infinitely divisible, which means that it is possible to buy or sell fractional shares.
iv. Investors can borrow or lend at the risk-free rate of return.
v. There are no taxes or transaction costs involved in buying or selling assets.
vi. There is no inflation or any change in interest rates, or inflation is fully anticipated.
vii. All investors have the same one-period time horizon.
viii. Information is freely and instantly available to all investors.
ix. Investors have homogenous expectations of risk, return and covariances of securities.
x. Capital markets are in equilibrium.

What are the uses of CAPM?

CAPM is used to evaluate share investments using the market benchmark risk-return to see if the investment gives a fair return. Second, CAPM can make an educated guess for pricing IPOs. In spite of its many shortcomings, CAPM is still used in the industry to offer insights into risk-return relationships in the market.

What are the assumptions of Arbitrage Pricing Theory?

APT, like the CAPM, has the following assumptions:
i. Investors have homogeneous beliefs;
ii. Investors are risk-averse utility maximizers;
iii. Markets are perfect, so that factors like transactions costs are irrelevant; and
iv. Returns are generated by a factor model.

What are the characteristics of good benchmark?

Good useful benchmarks should be
• Unambiguous – the asset class, securities, names and composition should be clearly stated;
• Investable – the benchmark portfolio should be practically and realistically investable as an actively managed portfolio;
• Measurable – the returns on the benchmark portfolio can be obtained from the market, and its performance measured;
• Consistent with the investment manager’s investment philosophy; and
• Bought in by the investment manager as an acceptable benchmark.

What is meant by the cumulative feature of the preference shares?

Although common in the past, most preference shares today do not have this cumulative feature that requires all past unpaid preference share dividends to be paid before any ordinary share dividends are declared. The purpose is to provide some degree of protection for the preference shareholder because
preference share dividends do not enjoy the same legal right as the interest that is paid to bondholders. The cumulative feature secures the rights of preference shareholders to receiving dividends before ordinary shareholders receive any.

What is the difference between absolute valuation approach and relative valuation approach?

In absolute valuation, the intrinsic value of the share is compared to its current market value. If the intrinsic value is greater than the market price, it is undervalued i.e. the market is valuing the share LOWER than what it is intrinsically worth. On the other hand, if the intrinsic value is less than the market value, then the share is overvalued i.e. the market is valuing the share HIGHER than its intrinsic worth.
In relative valuation, the share’s price multiple (Price / Earnings ratio, Price to Book Value ratio, etc.) is compared to its peers. A share that has a lower multiple is considered undervalued, and vice versa. In practice, a few relative valuation ratios are used together to obtain a more realistic valuation.

What are the disadvantages of P/E ratios?

i. The company may have a loss, and a negative denominator in the ratio will result in a meaningless number.
ii. Earnings can be very volatile, which makes future earnings hard to forecast with any degree of accuracy.
iii. Earnings are subject to accounting differences among companies because of differences in revenue recognition, treatment of expenses etc.
iv. The P/E ratio will be affected by capital structure changes e.g. if a firm increases its number of shares outstanding, the EPS will fall, resulting in a higher P/E ratio.

What are the competitive advantages of Depository Receipts for issuers?

For issuers, DRs offer a number of competitive advantages such as:
i. Including a broad and diversified investor exposure, which may improve liquidity;
ii. Enhanced visibility for the company’s products or services in an overseas market; and
iii. A flexible mechanism for raising capital.

How the maturity and the coupon of the bond affect the degree of reinvestment risk?

The maturity and coupon of the bond affect the degree of reinvestment risk.
First, for a given YTM and a given coupon rate, the longer the maturity, the more the bond’s total dollar return is dependent on the interest-on-interest to realize the YTM at the time of purchase. In other words, the longer the maturity, the greater the reinvestment risk.
Second, for a given maturity and a given YTM, the higher the coupon rate, the more dependent the bond’s total dollar return will be on the reinvestment of the coupon payments in order to produce the YTM expected at the time of purchase. This means that holding maturity and YTM constant, higher coupons will carry higher reinvestment risk because of the higher cash flow amount from the higher coupon. The converse is also true. So, a zero coupon bond has no reinvestment risk if it is held to maturity.

When the rising yield curve and declining yield curve are formed?

The rising yield curve is the most common. It is seen when the yields on short-term issues are low and rise consistently with longer maturities. A rising yield curve is a signal that interest rates are expected to rise in the future i.e. the entire yield curve will move upwards. The declining yield curve is seen when the yields on short-term issues are higher than the yields on longer maturities. This generally indicates lower interest rates in the future.

How market segmentation theory explains the interest rates in the market?

The market segmentation theory presumes that investors have their own maturity preferences, which are dictated by the nature of their liabilities. As an example, life insurance companies with long-term liabilities prefer long-term bonds while banks tend to prefer short-term liquid securities to match the nature of their deposits. The yield for each maturity is determined solely by the supply and demand in each “segment”. The theory holds that activities of long-term borrowers and lenders determine rates on longterm bonds. Similarly, short-term trades set short-term rates.

What are the benefits of investing in convertible bonds?

Convertible bonds offer investors a unique combination of an income stream from a fixed income security and an opportunity to participate in the capital appreciation of the underlying ordinary share. They offer upside potential and downside protection. The yield on a convertible bond is usually higher than the dividend yield of the underlying security but lower than the yield of a comparable ‘plain vanilla’ bond.
Most convertible bonds are callable. The possibility of a forced conversion when the share price is higher than the conversion parity value will limit the speculative appeal of the convertible bond.

What are the disadvantages of investing in unit trusts?

1. Sales charges. Relatively high sales charges are incurred when an investor buys into a unit trust, and transaction costs can be high if there is frequent buying and selling of unit trusts.
2. Management fees. Unit trusts pay annual management fees to the fund manager regardless the fund’s performance. Investors should compare the fees among different funds, as high management fees will affect the fund’s return.

What are the steps involved in calculating the offer price?

The steps
involved in calculating the offer price are:
i. Determine the market value of the unit trust’s securities at the exchange-listed offer prices. This is the NAV per unit.
ii. Add expenses related to purchase of securities such as stockbrokers’ commission and clearing fees.
iii. Add cash held by trust, and accrued income.
iv. Add manager’s initial charge.

How REITs are exposed to liquidity risk?

Although REITs themselves can be bought or sold on the exchange, the underlying properties of the REITs may not be easily liquidated because the market for physical real estate is private, with buyers and sellers dealing bilaterally with each other instead of through an exchange. This exposes REITs to liquidity risk as they cannot dispose or alter the composition of the investments quickly in a falling property market.