Friday, 22 November 2019

CFA Institute Investment Foundations Program: Chapter 15 – The Functioning of Financial Markets (Part II)


In a previous article, we introduced the CFA Institute Investment Foundation Program (Read more here).  It is a free program designed for anyone who wants to enter or advance within the investment management industry, including IT, operations, accounting, administration, and marketing.  Candidates who successfully pass the online exam earn the CFA Institute Investment Foundations Certificate.

There are total of 20 Chapters in 7 modules, covering all the essential topics in finance, economics, ethics and regulations.  This series of articles will highlight the core knowledge of each chapter.

Chapter 15 provides an overview of the functioning of financial markets. The learning outcome of chapter 15 is as follows:
·       Distinguish between primary and secondary markets;
·       Explain the role of investment banks in helping issuers raise capital;
·       Describe primary market transactions, including public offerings, private placements, and right issues;
·       Explain the roles of trading venues, including exchanges and alternative trading venues;
·       Identify characteristics of quote-driven, order-driven, and brokered markets;
·       Compare long, short, and leveraged positions in terms of risk and potential return;
·       Describe order instructions and types of orders;
·       Describe clearing and settlement of trades;
·       Identify types of transaction costs;
·       Describe market efficiency in terms of operations, information, and allocation.

Secondary markets are organised either as call markets or as continuous trading markets. In a call market, participants can arrange trades only when the market is called, which is usually once a day. In contrast, in a continuous trading market, participants can arrange and execute trades any time the market is open. Most markets, including alternative trading venues, are continuous.

Quote-driven markets, also called dealer markets or price-driven markets, are markets in which investors trade with dealers. These markets take their name from the fact that investors trade with dealers at the prices quoted by the dealers. Almost all bonds and currencies, and most spot commodities (commodities for immediate delivery), trade in quote-driven markets.

Quote-driven markets are often referred to as over-the-counter (OTC) markets because securities once literally traded over a counter in the dealer’s office. Now most trades in OTC markets are conducted electronically, by telephone, or sometimes via instant messaging systems.

In contrast to most bonds, currencies, and spot commodities that trade in quote-driven markets, many shares, futures contracts, and most standard options contracts trade on exchanges and alternative trading venues that use order-driven trading systems. Order-driven markets arrange trades using rules to match buy orders with sell orders. Orders typically specify the quantity the traders want to buy or sell. The order may also contain price specifications, such as the maximum price that the trader will pay when buying or the minimum price the trader will accept when selling.

Another type of market structure is the brokered market, in which brokers arrange trades among their clients. Brokers organise markets for assets that are unique and thus of interest as potential investments to only a limited number of investors.

A position refers to the quantity of an asset or security that a person or institution owns or owes. An investment portfolio usually consists of many positions.

Investors are said to have long positions when they own assets or securities. Examples of long positions include ownership of shares, bonds, currencies, commodities, or real assets. Long positions increase in value when prices rise. In contrast, positions that increase in value when prices fall are called short positions. To take short positions, investors must sell assets or securities that they do not own, a process that involves borrowing the assets or securities, selling them, and repurchasing them later to return them to their owner.

Market orders are instructions to obtain the best price immediately available when filling the order. They generally execute immediately but can be filled at disadvantageous prices. A limit order specifies a limit price—a ceiling price for a buy order and a floor price for a sell order. They generally execute at better prices, but they may not execute if the limit price on a buy order is too low or if the limit price on a sell order is too high.

Stop orders specify stop prices; the order is filled when a trade occurs at or above the stop price for a buy order and at or below the stop price for a sell order. Traders often use stop orders to stop losses on their long positions.

Intermediaries help traders clear and settle orders that have been filled. The most important clearing activity is confirmation, which is performed by clearing houses. Settlement follows confirmation; at settlement, the seller must deliver the security to the clearing house and the buyer must deliver cash.

The costs associated with trading are called transaction costs and include two components: explicit costs and implicit costs. Brokerage commissions are the largest explicit trading cost. Implicit trading costs result from bid–ask spreads, price impact, and opportunity costs. Traders usually choose order submission strategies that minimise transaction costs.

Well-functioning financial markets are operationally, informationally, and allocationally efficient. Operationally efficient markets have low transaction costs. Informationally efficient markets have prices that reflect all available information about fundamental values. Allocationally efficient economies put resources to use where they are most valuable.





Which of the following orders will most likely be executed immediately?



pollcode.com free polls

Thursday, 21 November 2019

Why are Lawmakers so Worried about Libra?



Consumers using Libra will very soon be able to make purchases, according to Facebook. The number of purchases will be limited at first. Zuckerberg believes that Libra would “extend America’s financial leadership as well as our democratic values and oversight around the world.” He further emphasized that if the U.S. doesn’t develop a cryptocurrency like Libra, then China would.

Calibra, with other members from the non-profit Libra Association will manage the coin together. However, some of the companies that had originally signed onto the project have reportedly begun quitting, including PayPal, eBay, Visa and Mastercard. And recently, lawmakers started to grill Zuckerberg on Libra’s issues. The cryptocurrency has drawn heavy scrutiny from lawmakers since it was revealed. What are the issues? Why would PayPal and the others withdraw from Libra? What are the lawmakers worried about?

U.S. Treasury Secretary Steve Mnuchin raised concerns that the coin could be used for money laundering. Tax avoidance, drug dealing, or terrorism, could also go undetected. President Trump argued that Facebook should be required to obtain a banking charter to move forward with its plan. Democratic lawmakers have also taken issue with the cryptocurrency — Rep. Maxine Waters of California proposed legislation that would prohibit major tech companies from becoming financial institutions or offering cryptocurrencies. The fear is that if a group with such power as Facebook with its 2.4 billion users enters the financial market, the stability of this market could be at risk. What's more, that could stifle the role of the dollar as the world's leading currency. And that would have dramatic consequences for U.S. foreign policy.

Many sanctions against unpopular regimes or dictators work because of U.S.’s currency lever. In a digital currency world these sanctions would probably not work anymore. Whether money laundering or terror financing, if money flows are not transparent, things could get out of control.

And can we trust Facebook with our financial data? At a recent hearing (23 Oct 2019) in the House Financial Services Committee, Facebook said that no data from Calibra, would be shared with the social network. But we need to be reminded that Facebook was recently fined $282,000 by Turkish authorities for violation of data protection laws. And close to 50 million users had their personal information exposed in an attack on its computer network in September 2018. So the upshot of the matter is security, abuse and sheer power of Facebook. With no regulatory authority to oversee it is answerable to none if it goes forward with Libra.


Reference:
1. JacobPassy, Why Facebook’s Libra coin could become a big pain in your wallet www.marketwatch.com/
2. Henrik Böhme, Opinion: Facebook's Libra and the power of money, www.dw.com
3. Lisa Eadicicc, Lawmakers just grilled Mark Zuckerberg about his company’s big plan to upend the way we send money around the world www.businessinsider.my

Wednesday, 20 November 2019

Should Malaysia Ratify CPTPP?



The Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or the CPTPP, is a free trade agreement between 11 countries in the Asia-Pacific region. The signatories of the agreement, as of March 2018, were Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam.

The CPTPP is the successor to the Trans-Pacific Partnership (TPP), which was the original free trade agreement (FTA) between the United States and the 11 members of the CPTPP. The TPP was an ambitious FTA that had been negotiated for almost a decade under US leadership. Not only was the agreement broad, covering two-fifths of the world economy, it was also comprised of 30 chapters that covered areas from tariff reductions to labour standards and intellectual property rights. The concluded TPP Agreement was signed in New Zealand in February 2016 by all 12 countries.

However, on 23 January 2017, the US government decided to withdraw from the TPPA. Because the US accounted for 60% of the combined GDP of the 12 TPP members, the agreement could not enter into force without its participation. Nevertheless, in light of US withdrawal, the governments of the remaining 11 countries affirmed the economic and strategic importance of the TPP and met on several rounds to find ways to implement the agreement. On 8 March 2018, the 11 countries signed the CPTPP, essentially agreeing to enable the ratification of the Agreement in order to bring it into force.


Source: IDEAS, CPTPP: The Case for Ratification (January 2019)

Malaysia and the CPTPP

Malaysia signed the CPTPP along with the other signatories, however following the General Election in May 2018 the Pakatan Harapan government expressed scepticism over the benefits of the CPTPP. To date Malaysia has not ratified the deal.
  
What are the benefits of the CPTPP?

The benefits of the CPTPP primarily relate to the enhancement of trade among countries in the Asia-Pacific. If fully implemented, the 11 CPTPP countries will become a consolidated economy that represents 495 million consumers and 13.5% of global GDP. It is estimated that the CPTPP will generate global income benefits worth US $147 billion.

·       An integrated market of 495 million people with a combined output of US$10 trillion, representing 13.5% of the world economy.

·       According to IDEAS, Malaysia will prove to be the biggest winner of the CPTPP as the agreement would provide export access to markets that benefit palm oil, rubber, and electronics.

·       USD$147 billion in global income gains.

·       Hailed as the 21st century trade agreement.

The CPTPP will give Malaysia market access to Canada, Mexico and Peru- three countries with whom Malaysia has no free trade agreement and representing a combined market size 10 times bigger than the Malaysian economy. According to a study by Moody’s, Malaysia will prove to be the biggest winner from the revised CPTPP agreement. That is because the deal will provide export access to markets that will benefit palm oil, rubber, and electronics exporters.

Source: IDEAS, CPTPP: The Case for Ratification (January 2019)
Figure 1 above illustrates the significant economic benefit for Malaysia of acquiring access to significant new markets in Canada, Mexico and Peru

What are the concerns?
Rashmi Banga (UNCTAD) in a paper written in March 2019, suggests that Malaysia’s exports will rise marginally as Malaysia already has FTAs with top 3 export markets i.e. Japan, Singapore and Australia. If Malaysia remains out of CPTPP the decline in exports is much smaller than the rise in imports if it joins the CPTPP. The estimated tariff revenue loss to Malaysia of joining CPTPP is USD1.6 billion per annum.

IDEAS lists the arguments against CPTPP and the counter-arguments in favour thereof in their paper dated January 2019. Briefly, these include: Investor-State dispute settlement mechanism; price of medicines will rise; and constrained policy “space” in health, capital controls and procurement.

Eonomist Jomo Sundaram says a lot of “propaganda” to ratify CPTPP is based on falsehood. So he has urged Putrajaya to do nothing. He cites the Rashmi Banga paper to fortify his view. The downside according to him is Proton and Perodua will be impacted severely and plastic waste imports from Japan, Australia and Singapore would increase. The biggest mis-information is from those pushing for the trade pact, according to Jomo.


IDEAS on the other hand sees the benefits from:
·       Strengthened transparency and anti-corruption measures;
·       Improved governance of GLCs;
·       Increased accountability to Government; and
·       More transparent procurement system

Historically, Malaysia’s economic growth is driven by openness to trade. And so ratification will lead to reforms, sustainable development and good governance.

But how do we end this debate? The Government could be more transparent with its views on CPTPP and have public forums to discuss the issues. Also, the Government could appoint independent trade expert/s to review the pros and cons of CPTPP and table a bill in parliament for debate. That may take some time but it is better than be swayed by sentiments that never seem to end.

Reference:
1. CPTPP: The Case for Ratification, Laurence Todd, Manucheher Shafee, IDEAS
2. Say goodbye to Proton if you ratify trans-pacific trade pact, Jomo warns Government, Robin Augustin,  (www.freemalaysiatoday.com)
3. CPTPP: Implications for Malaysia’s Merchandise Trade Balance, Rashmi Banga, March 15, 2019

Tuesday, 19 November 2019

Negative Interest Rates: What Does It Mean?


Can you imagine going to a bank and they said they would pay you if you took out a loan with them? That’s “negative” interest rates. It is ridiculous, counterintuitive but that happens in Sweden, Germany, Denmark, Switzerland and Japan.
From a practical perspective, the mechanics of negative interest rates are clear – borrower agrees to pay USD 1,000 in a year but the lender extends USD 1,020 (or a negative yield of 2%).
Wouldn’t the lender be better of keeping the cash? That’s another story! Standard economic theory would suggest interest rates should be reasonable enough for depositors to save. And low enough for businesses to borrow or invest. Economic theory has no room for negative rates. 
Interest rate is determined by the interaction of borrowers and lenders. Interest rates rise if there are more borrowers seeking funds than depositors (or savers). And borrowers are willing to pay for scarce funds. The converse is also true.
The interventions of central banks (especially the Fed, The European Central Bank and the Bank of Japan) have been very active since the financial crash of 2008. The Fed, under Chairman Powell, made a good faith effort over the last two years to get out of the business of suppressing interest rates. But the global efforts of the European Central and the Bank of Japan were in the opposite direction. Suppressing interest rates by them have put the Fed in an untenable position. Last month the Fed responded by cutting interest rates and signaling that more cuts might be coming. Despite eleven years of economic growth, we are back to a world of low interest rates and negative interest rates in much of the developed world. Central banks turn to them in the first place to stimulate inflation (Japan is an example) and defend currencies (Denmark and Switzerland). The effects of which were property prices rose; contradicted monetary policy and savers still saved.
Where do we go from here? No one knows. The hyperactivity of central banks has had some long-term damaging influences. Government debt has ballooned out of control, without the discipline of realistic interest rates to temper political ambitions. Corporate debt has also climbed to new heights. Low interest rates encourage companies to borrow cheap funds and buyback their own stock instead of paying workers higher wages. The world has learned how to manipulate fiat money for short term advantages. With the “quantitative-easing cat” out of the bag, populist like Bernie Sanders can just print money to finance healthcare, student loans and other popular schemes.
It will be a long and difficult road back to the inevitable reality that the world is not flat and that true purchasing power is represented by money earned and not just printed. In the meantime, it might not be a bad idea to buy a little gold and borrow for a good investment.

Reference:
1.     Gordon C. Boronow, Op-Ed Contributor, Negative interest rates? How does that work?, 27 August 2019;
2.     Reuters, Explainer: How does negative interest rates policy work? 13th September 2019;
3.     Daniel Straus, Business Insider, Trump has ramped up calls for negative interest rates. Here’s what they are and why they matter, 11th September 2019;
4.     Chris Carosa, Forbes, What are “Negative’ Interest Rates and How Can You Make Money From Them?, 20th August 2019
5.     Alex Graham, Analyzing the Effects of Negative Interest Rates Across Five Economies, https://www.toptal.com/finance/market-research-analysts/effects-of-negative-interest-rates


Monday, 18 November 2019

CAAM Downgraded: No Material Impact?



On 11 November 2019, the U.S. Federal Aviation Administration (FAA) downgraded Civil Aviation Authority of Malaysia (CAAM) to Category 2 regulator. CGS-CIMB Research (Nov 12, 2019) had the headline “No material impact on aviation sector...” as reported in The Edge Financial Daily (Nov. 12, 2019). Is that true?

Granted FAA’s downgrade is not on assessment of the safety of airlines, airports and air traffic control services in Malaysia, the dire implications remain. CAAM, in FAA’s judgment, may not be able to perform regulatory oversight due to its various shortcomings. And that has issues on airlines, tourism promotion, code-share, new routes to the U.S. and so forth.

MAS will lose its code-share arrangement with American Airlines. Air Asia cannot increase services to the U.S. Japan and South Korea may impose restrictions on MAS and Air Asia. Higher cost for sale and leaseback transactions for Air Asia. Tourism Malaysia’s plans to promote 2020 as Visit Malaysia Year will now be in jeopardy. Public perception of Malaysia’s carriers can turn negative, Malaysian pilots and engineers are not employable outside Malaysia and repair and overhaul business is now curtailed.

Why the downgrade? Many industry professionals and academicians have forewarned the inherent weaknesses of CAAM. Insufficient staff, poor retention rate, underpaid, audit follow-up weaknesses all pointed to a looming disaster. After MH 17 and MH 370, surely the regulator and aviation experts would have examined how best to improve regulation and services. Not really, we believe in the Malaysian way – mediocrity rules the day! A CAAM Board member said if Tony (Fernandes) did not launch flights to Honolulu, the FAA would not have come in the first place! Actually, if we have had no local airline or aircraft we will not be in this position!

Our PM said he was not aware of the details of the downgrade. The downgrade places us in the same group as Thailand, Bangladesh, Ghana and Costa Rica. To return to Category 1 will take us about two years. Thailand was downgraded in 2015 but has yet to return to Category 1.

So what can we learn? A major overhaul is necessary at CAAM. Rectifying shortcomings and having a vision will be helpful. Getting back to basics, diversity and meritocracy in employment, and setting excellence in standards are something to pursue if new Malaysia is to take hold. Otherwise, we will never be ready to meet international standards in any field.

References:
1. FAA downgrade has nothing to do with safety of Malaysia’s aviation sector, The Edge Financial Daily, 13 Nov 2019
2. No material impact on aviation sector seen FAA downgrade, The Edge Financial Daily,
14 Nov 2019
3. Malaysia’s aviation industry bogged down by inherent weaknesses – Maybank, Bernama, 12 Nov 2019
4. US downgrades Malaysia’s air safety rating, Channel News Asia, 12 Nov 2019

Friday, 15 November 2019

CFA Institute Investment Foundations Program: Chapter 15 – The Functioning of Financial Markets (Part I)



In a previous article, we introduced the CFA Institute Investment Foundation Program (Read more here).  It is a free program designed for anyone who wants to enter or advance within the investment management industry, including IT, operations, accounting, administration, and marketing.  Candidates who successfully pass the online exam earn the CFA Institute Investment Foundations Certificate.

There are total of 20 Chapters in 7 modules, covering all the essential topics in finance, economics, ethics and regulations.  This series of articles will highlight the core knowledge of each chapter.

Chapter 15 provides an overview of the functioning of financial markets. The learning outcome of chapter 15 is as follows:

·       Distinguish between primary and secondary markets;
·       Explain the role of investment banks in helping issuers raise capital;
·       Describe primary market transactions, including public offerings, private placements, and right issues;
·       Explain the roles of trading venues, including exchanges and alternative trading venues;
·       Identify characteristics of quote-driven, order-driven, and brokered markets;
·       Compare long, short, and leveraged positions in terms of risk and potential return;
·       Describe order instructions and types of orders;
·       Describe clearing and settlement of trades;
·       Identify types of transaction costs;
·       Describe market efficiency in terms of operations, information, and allocation.

Investors buy and trade securities that are issued by companies and governments that need to raise capital. Markets in which companies and governments sell their securities to investors are known as primary markets. Each type of security has its own primary market. For example, in most countries, there is a primary market for shares issued by companies or bonds issued by the sovereign (national) government.

Investors also trade securities, such as shares and bonds, as well as contracts, such as futures and options. These trades take place in secondary markets. When trading securities and contracts in secondary markets, investors often obtain assistance from trading services providers, such as brokers and dealers.


Investment banks play an important role in helping issuers raise capital. In a public offering, they help the issuer identify potential investors and set the offering price for the securities.

In underwritten offerings, the investment bank guarantees the sale of the securities at the offering price negotiated with the issuer. In contrast, in a best efforts offering, the investment bank acts only as a broker and does not take the risk of having to buy securities.

A shelf registration allows a company to sell shares directly to investors over a long period of time rather than in a single transaction.

Other ways to issue securities in the primary markets are through private placements or rights offerings. In a private placement, companies sell securities directly to a small group of investors, usually with the assistance of an investment bank. In a rights offering, companies give existing shareholders the right to buy shares in proportion to their holdings at a price that is typically set below the current market price of the shares, thus making the exercise of the rights immediately profitable.

Secondary markets require a trading venue—either physical or electronic—where trading among investors can take place. Most secondary market trading globally is now done via electronic trading systems.

Exchanges are the most common type of trading venue, but alternative trading venues, which have their own rules, have gained in popularity. The two main distinctions between exchanges and alternative trading venues are that exchanges typically have regulatory authority and more trade transparency than alternative trading venues.

One type of alternative trading venue is a crossing network, which is an electronic trading system that matches buyers and sellers who are willing to trade at prices obtained from exchanges or other alternative trading venues. Crossing networks are popular with investors who want to trade large blocks of securities without risking moving the price of those securities by submitting an order to an exchange.

Some alternative trading venues are known as dark pools because of their lack of transparency. Dark pools do not display orders from clients to other market participants. Large institutional investors may transact in dark pools because market prices often move to their disadvantage when other traders know about their large orders.


Relative to public offerings, private placements provide:
 
pollcode.com free polls

Thursday, 14 November 2019

Malaysians Cannot Afford a Home?


According to the median multiple methodology developed by Demographia International and recommended by the World Bank, United Nations and Harvard University, a house is deemed affordable if it is priced not more than three times the annual household income, said BNM’s Financial Surveillance Department director Qaiser Iskandar Anwarudin.

In Malaysia, the median multiple affordability is already higher than not three but four times since 2002. It peaked at 5.1 times in 2014 and 5.0 times in 2016.

Source: DOS, NAPIC, The Star

According to Khazanah Research Institute, the median house price for the country grew at a compound annual growth rate (CAGR) of 23.5% between 2012 and 2014, while median household income grew at only 11.17% over the same period, less than the half of the rate of increase in house price.


Not only reducing buyer’s affordability, higher house prices also lead to housing loan rejection. According to Bank Negara director of financial surveillance Qaiser Iskandar Anwarudin, 80% of the housing loans were rejected because the house was priced more than three times the applicant’s annual income ratio.

Kuala Lumpur, Selangor, Penang and Johor are four states facing serious housing affordability issues in Malaysia. In Kuala Lumpur, for example, the actual house price median is RM793,000 while the maximum affordable level is RM454,000. Negri Sembilan has the most unaffordable unsold properties. For context, about 92% of unsold units in the state are priced above the maximum affordable house price, according to Qaiser.

There are various government housing schemes to facilitate homeownership, including Skim Rumah Pertamaku, Skim Jaminan Kredit Perumahan, Skim Rumah Selangorku, Skim Perumahan Mampu Milik Pulau Pinang, PR1MA, and so on. In the Budget 2020, the Finance Minister Lim Guan Eng announced that the government will collaborate with financial institutions in introducing a Rent-To-Own (RTO) financing scheme. Under this scheme, the applicant will rent the property for up to five years and after the first year, the tenant will have the option to purchase the house based on the price fixed. According to Lim, through this scheme, financing of up to RM10 billion will be provided by the financial institutions with support from the government via a 30 per cent or RM3 billion guarantee.

Will this work? No, not really! Why? The root case is supply of affordable housing. And that is related to land price, cost of construction, location and so forth. So the idea of 1 million new homes over 10 years as the Ministry of Housing and Local Government suggests could be a “pie in the sky” or more appropriately “house in the sky”?


Reference:

1. Many cannot afford a home in the city, 27 Apr 2019, The Star
2. Houses in Malaysia ‘seriously unaffordable’, says Bank Negara, 24 Oct 2019, Free Malaysia Today
3. House prices beyond affordability of most Malaysians, 25 Oct 2019, The Star
4. Budget 2020: Purchasing of homes easier with rent-to-own scheme, 11 Oct 2019, MalayMail