INVESTMENT ANALYSIS

GSM 5421
Lecture 2

By Dr. Chen
1

Watch your thoughts, they become

words
Watch your words, they become actions
Watch your actions, they become habits
Watch your habits, they become
character
Watch your character, they become your
destiny
2

Content
Asset class
Financial instruments
Asset allocation

Investment in Money Market

MONEY MARKET

Placement for
Excess Funds
to generate
return

Market to manage
liquidity
For financial
institutions and
corporations
Borrowing rate
Brokers

Exchange debt
instrument eg. T-Bills,
CD,Repo
Or interest rate
Less than 1 year

Financial
institutions

What is a money market?

Transactions in short-term funds

borrowing and lending of debt
instruments with an original maturity
of less than one year
Transaction can be exchange of
money for financial assets (secured)
or an interest in a financial asset
(unsecured)
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Money Market

Primarily used by Banks/Corporations

Interbank borrowing & placement
Typical Financial Instruments
Treasury Bills
Certificate of Deposit (CD)
Bankers Acceptance
Cagamas bonds & notes,
Bank Negara Bills
Khazanah bonds
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Treasury Bills (T-Bills)

Short-term debt instruments of

government with typical maturities
of 3 to 12 months
Zero-coupon
Most liquid of money market
instrument and most secure
Almost risk free
Bid and Ask price
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Negotiable CDs

CD (Certificate of deposits) a negotiable

instruments issued by bank, acknowledging
deposit and promise to pay bearer
Equivalent to T-bills by government
Pays annual interest payments equal to a
fixed percentage of original purchase price
Maturity of 1 to 12 months
Could be resold in secondary market
Most large commercial banks issue nego CDs

10

Commercial paper

Short-term debt instrument issued by

corporation and other foreign enterprises with
high credit standings eg. GE, Ford
Have minimum denomination (100k)
Limited secondary market, usually hold to
maturity
Supported by backup line of bank credit
Growth due to issues by non-financial firms

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Bankers Acceptance

Created for financing international trade

Is a bank draft (a guarantee of payment)
issued by a firm and payable on some
future date
Issue by bank for a fee
Guarantee the draft be paid even default
by firm. Creditworthiness of firm
substitute by bank
Party that accept draft resell in secondary
market at discount. Similar to T-Bills
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Repurchase Agreement (REPO)

Short-term agreements - seller sells

government security to a buyer and
simultaneously agrees to buy the
securities back on a later date at a
higher price
Basically using government security
(eg. T-Bills) as collateral and different
price is the interest rate
An important source of fund for banks
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Government Funds

Overnight loans between depository

institutions (banks) of their deposits
at central banks
Market for excess reserves
Banks can borrow from central bank
or other banks if reserve is low
Money transfer through central bank
transfer system
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Bond Markets

IOU

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What is a bond?

A long-term debt security where

bond buyer lends the face amount to
the bond issuer fixed income
The certificate is the evidence of a
lender-creditor relationship
Contains the master agreement (or
bond indenture or deed of trust)
It can be bought and sold
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Why Issue Bond?

Longer term period of financing

compared to bank loan
Provide better interest rates
Borrowing process more efficient and
less expensive
Larger base of investors through a
single, uniform instrument
Do not weaken control/dilute equities
of companies compare to stocks
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What are the basic terms?

Agreement will contain among others:

Amount of loan the amount issuer
agreed to pay upon maturity
Rate of interest a specified coupon rate
or nominal rate Some bonds have interest
rate that fluctuate known as variable rate
bonds

Eg. RM1,000 face value bond with coupon of

8% pays bondholder RM80 per year
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What are the terms? (cont)

Schedule of interest payments

6-month interval (US), European (yearly)
Term (maturity) length of time until
principal is repaid eg. Short bond 3 to 5
years.
Call feature allows issuer to call in the
bonds and repay them at a predetermine
price before maturity to retire expensive
debt and refinancing at lower rate**(paid a
call premium)
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What are the terms? (cont)

To increase creditworthiness/appeal
Sinking fund cos allocate a
certain amount of earnings into the
fund to pay bondholders
Insurance buy insurance in case
of default
Letter of credit a form of
guarantee
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Bond Pricing

Depended on a number of factors:

- ability of issuer to repay
- collateralized
- level of prevailing interest rates
**General principle: bond prices
when interest rate
and vice versa
For shorter term of maturity, less volatile
the price adjustment
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Other Factors

Business Cycle business upswing

increase borrowing compete for funds
interest rate goes up
Inflation cost of goods rise interest
rate rise
Flow of funds supply (credit available)
and demand aspect (future borrowing)
Reinvestment of interest (total rate of
return)
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Types of Bonds

Government Bond
Corporate Bond
International Bond

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Government Bond
Treasury Bills (less than a year) Zero
coupon bonds
Notes (MGS) (3-10 years)
Government Investment Issues (GII)
**Registered bonds of ownership
**Bearer bonds no registration

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Corporate Bond

Also known as private debt securities

(PDS)

Issued by private firms

Semi-annual interest payments

Subject to larger default risk than

government securities

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Corporate Bond

Mortgage-back securities (assetback)

Convertible bonds to stocks
Floating rate bond coupon rates
periodically reset according to a
specified market rate
Preferred stock a type of fixed
income security
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International Bond
1.

Issued by borrower from a country

other than the one in which bond is
sold denominated in currency of
country marketed
eg. Yankee Bond, Samurai Bond or
Bulldog Bond

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Mortgages and Mortgage-Backed

Securities

Developed in the 1970s to help

liquidity of financial institutions
Proportional ownership of a pool or a
specified obligation secured by a pool
Market has experienced very high
rates of growth
Sub-prime crisis
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Mortgage-backed Securities
Outstanding, 1979-2007

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Rating of Bond

A rating can refer to a firm's specific financial

obligation or to its general creditworthiness.
Sovereign Credit Ratings
a country's overall ability to provide a secure
investment environment.
Factors: economic status, transparency in
the capital market, levels of public and
private investment flows, foreign direct
investment, foreign currency reserves,
political stability

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Sovereign rating

Institutional investors important when making

a decision to invest money abroad.
Understanding of the level of risk associated
with investing in the country.
A country with a sovereign rating will therefore
get more attention than one without.
Countries will strive even more so to reach
investment grade lower cost of borowing.
In most circumstances, a country's sovereign
credit rating will be its upper limit of credit
ratings.
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Corporate Rating

To rate creditworthiness of firms

Add in features to increase ratings
Bond ratings are expressed as letters
ranging from 'AAA', which is the
highest grade, to 'C' ("junk"), which is
the lowest grade.
Different rating services use various
combinations of upper- and lower-case
letters to differentiate themselves.

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Rating Agencies

Rating agencies:
Moodys Investors Service (Moodys),
Standard and Poor (S&P), Fitch and
Duff & Phelps. In Malaysia RAM
and MARC
*if issuer has more than one rating
agency, the ratings are usually the
same,
Split rating differ by one level
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Credit Rating
S&P

Moodys

Grade

S&P

Moodys

A1+

P1

Best Quality

AAA

Aaa

AA+

Aa1

A1
A2

P2

A3

P3

Highest Quality AA

Upper Medium

Short-term ratings

Medium

Aa2

AA-

Aa3

A+
A

A1
A2

A-

A3

BBB+
BBB

Baa1
Baa2

BBB-

Baa3

Long-term ratings

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Credit Rating

AAA and AA: Very high creditquality investment grade

AA and BBB: Medium credit-quality
investment grade
BB, B, CCC, CC, C: Low credit-quality
(non-investment grade), speculative
or "junk bonds"
D: Bonds in default for non-payment
of principal and/or interest
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Credit Rating

Rating agencies carry out risk

evaluations independently
Ratings can be changed
Before that, will issue credit watch
with positive/negative implications
Affect rate of interest one level can
be as high as 2% per annum
Credit risk is compared to govt
instrument
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Equity Securities

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SHARES

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Definition

It involves company shares which

represents part ownership by the investor
in a particular company.
Ownership of equities - entitle the investor
to a portion of the company's profits
through dividends.

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Ordinary/Common Shares

Ordinary shares give holders the

rights of ownership in the company,
such as the right to share in the profits,
the right to vote in general meetings
and to elect and dismiss directors.
Form the bulk of a company's capital
and have no special rights over other
shares. In the event of liquidation, rank
after all other liabilities of the company.
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Right of Shareholders

Right to sell the stocks

Right to vote by proxy
Right to bring suit for damages if
corporations/managers fail to meet their
obligations
Right to certain information from the
corporation
Certain residual rights following companies
liquidation

Preference Share

Carry the right to dividend (normally

fixed) which ranks for payment before
that of ordinary shareholders.
Distribution of assets upon dissolution
of the company.
Carry no voting rights, but voting
rights may be made contingent upon
failure to pay dividends on preference
shares for a certain period of time.
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Bonus Issue

Distribution of capital funds (usually

from a revaluation of assets or a
share premium reserve) to
shareholders in the form of shares
for which payment is not required.
Eg. Bonus issues of 2 for 1 holders
of 2 lots will get 1 free

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Share Split

When a company reduces the paid or

face value of its shares, and issues
further shares in the same
proportion
i.e. 100,000 RM 2 ordinary shares
would be split into 200,000 RM 1
ordinary shares.

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Rights

Rights
Raise additional capital by offering to
existing shareholders the rights to
subscribe for new shares, at a price
usually below the current market price.
These rights, while current, attract a price
of their own and can be traded on any
stock exchange.
Rights Issue
A rights issue can be granted to
stockholders to buy stocks in the company,
often below market price.
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Warrants

Made their debut in 1990

Issued as companies sweetener in
bond/rights/loan stock issue
Warrants may be issued over securities, a
portfolio of securities, a stock price index,
currency or commodities.
Tradable and value fluctuate as to price of
shares to which they relate (underlying
share/mother share)
Has no rights to dividends and no voting
rights
Similar to options
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Derivatives Markets

Markets for trading instruments that

provide contingent claims on underlying
assets
Main use - to hedge against volatility in
the price of the underlying assets
Examples - forwards, futures, options and
swaps
Instruments traded - stock index, interest
rate & commodity futures
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Mutual Funds/Unit Trusts

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Investment Companies

Pooling of assets from investors

Invest in wide ranging of securities
Claim on portfolio in proportion
invested
Big role in market
Financial Intermediaries

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Role of Investment Companies

These companies perform several

important functions for investors:
Administration & record keeping
Diversification & divisibility
Professional management
Reduced transaction costs

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Types of Investment Companies

Unmanaged
Portfolios fixed

Managed Investment Companies

Continue to be bought and sold

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Managed Investment Companies

Open-End
Open-end: shares outstanding change
when new shares are sold or old shares
are redeemed to fund
Priced at Net Asset Value(NAV)
Closed-End
no change in shares outstanding unless
new stock is offered
Priced at Premium or discount to NAV
Traded on organized exchange
Purchased through brokers
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Mutual FundsInvestment Policies

Money Market
Equity
Sector
Bond
Balanced
Asset Allocation and Flexible
Index
International
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How Funds Are Sold

Direct-marketed funds

Sales force distributed

Revenue sharing on sales force

distributed
Potential conflicts of interest

Financial Supermarkets

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Mini-Case Study - EPF

Mini-Case Study - EPF

Investment strategy of EPF

Why should we care?
Concept of security analysis
(selection) and portfolio
management

Dividends payout - EPF

1952 - 1959

2.50

1995
1996

1960 - 1962

4.00

1997 - 1998

6.70

1963

5.00

1964

5.25

1965 - 1967

5.50

1968 - 1970

5.75

1971

5.80

1972 - 1973

5.85

1974 - 1975

6.60

1976 - 1978

7.00

1979

7.25

1980 - 1982

8.00

1983 - 1987

8.50

1988 - 1994

8.00

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

6.84
6.00
5.00
4.25
4.50
4.75
5.00
5.15
5.80
4.50
5.65
5.80
6.00
6.15
6.35

Year

Percent

7.50
7.70

Mini-Case Study - EPF

Money
market6.8%
Loans and
Bonds
37.3%

Fund raising in the capital market

Group Project 1
Example: shares or bonds

Private Placement vs Initial Public

Offering

Private Placement
sell shares directly to small group of
institutional or wealthy investors;
- Cheaper without costly and extensive
preparation.
Do not trade in secondary markets
reduces liquidity; and
- prices investors pay

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Private vs Public

Private declare lower profits

Public declare higher profits to
remain attractive
Going public
Owners selling out
Raise capital
Diversification
Liquidity
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Why remain private ownership?

Flexibility, control and not subject to public

disclosure and accountability requirement
Not many companies are attractive to
public investors
Cost of IPO prohibitive compared to bank
funding (eg. legal, accounting, preparatory
and commission rate charged by
investment banks for marketing and
selling shares)

How Firms Issue Securities

Primary
New issue
Key factor: issuer receives the
proceeds from the sale
Secondary
Existing owner sells to another party
Issuing firm doesnt receive proceeds
and is not directly involved
65

Initial Public Offerings (IPOs)

Tycoon Vincent Tan likes Facebook for its va

lue
KUALA LUMPUR: Tycoon Tan Sri Vincent Tan has
no immediate plans to sell the shares that he
owns in Facebook as he still sees potential value
in the world No. 1 social networking site
66

Initial Public Offerings

IPO road shows to publicize offering

to generate interest and provide
information
- Book building exercise
- Pricing strategy

Under-pricing
Post sale returns
Cost to the issuing firm
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Role of Investment Banks

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Role of Investment Banks

Investment bankers advise firms

regards term of sale of securities
Marketed by underwriters
Two alternative arrangement:
i.
ii.

purchase and resell to public

Best efforts agreement act as
intermediary

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Relationship among firm, underwriter

and investors

Underwriting
syndicate

Issuing Firm

Lead Underwriter

Investment
Banker A

Investment
Banker B

Investment
Banker C

Investors
70

Example of IPOs in Malaysia

Satisfy requirement for listings such as:

Initial capital requirement different Boards
- Main Market
- Mesdaq market
At least 25% shares offer
Financial records
Articles of Association
Issuances of prospectus
Shelf Registration
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Corporate Governance Issues

Essential Element of Corporate

Structure

Board of Directors
Management
Corporate laws provide flexibility to
corporation to determine capital and
governance structure
Can rely on market for capital to create
competition that allow shareholders to
choose
Once invested, power to influence limited

Board Duties

Duty of loyalty
To the shareholders (eg. Cross
directorships)

Duty of care
Exercise due diligence in making
decisions

Issues Related to Boards

Board-Management Relationship
CEO Chairman
Director Compensation
Interlocks Directorship
Independent Outside Directors
Size

Management

Position of Chairman and CEO

New terms COO, CFO, CTO
Day-to-day running of corporation
Execute strategy and plans approved by
Board
Meet specific targets set
Long-term goals vs. short-term goals eg.
Long-term employability, career
development, rules and procedure,
corporate governance, procurement and
benefits

Corporate Theories

Agency Theory

Principal-agent problem
Principal employ management to
take care of interest
Agents reward with pecuniary
benefits and entrench position
Moral hazards
How to ensure agency problem is
minimized

Financial Issues

Conflict of Interest

Free Rider Problems

Moral Hazard

Free Rider Problems

Prisoners dilemma
Minority shareholders costly to
monitor performance of management
Depend on large institutions or
bigger shareholders eg. Provident
funds
Conflict of interest between large
institutions and owners

Mitigation Factors

Executive Compensation
Role of board of directors
Outsiders (Security analyst etc)
takeover threat

We can see the past but not

influence it. We can influence the
future but not see it

THE END

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