Investment Analysis

Farhan Javed
M14MBA031
 SWAPS
(Interest Rate
&
Currency Rate)
 Swap
A swap is an agreement between
counter-parties to exchange cash flows
at specified future times according to
pre-specified conditions.
 Interest Rate Swap
 An agreement between two counterparties
in which one flow of future interest
payments is exchanged for another based on
a specified principal amount.

 Interest rate swaps usually involve the

exchange a fixed interest rate for a floating
rate, or vice versa.
 Example
Party 1 (Floating Rate)
Assume that Charlie owns a $1,000,000
investment that pays him LIBOR + 1% every
month. As LIBOR goes up and down, the payment
Charlie receives changes.
Party 2 (Fixed Rate)
Now assume that Sandy owns a $1,000,000
investment that pays her 1.5% every month. The
payment she receives never changes.
 Example Contd.
So Charlie and Sandy agree to enter into an
interest rate swap contract.

Under the terms of their contract, Charlie agrees

to pay Sandy LIBOR + 1% per month on a
$1,000,000 principal amount. Sandy agrees to
pay Charlie 1.5% per month on the $1,000,000
Principal amount.
 Example Contd.
Assume: LIBOR = 0.25%
 Charlie receives a monthly payment of
$12,500 from his investment ($1,000,000 x
(0.25% + 1%)).
 Sandy receives a monthly payment of $15,000
from her investment ($1,000,000 x 1.5%).
 Example Contd.

Now, under the terms of the swap agreement,

Charlie owes Sandy $12,500 ($1,000,000 x
LIBOR+1%) , and she owes him $15,000
($1,000,000 x 1.5%).

The two transactions partially offset each other

and Sandy owes Charlie the difference: $2,500.
 Currency Swap
A currency swap is a foreign-exchange
agreement between two institute to exchange
aspects (namely the principal and/interest
payments) of a loan in one currency for
equivalent aspects of an equal in net present
value loan in another currency.
 Example
Suppose the British Petroleum Company plans to
issue five-year bonds worth £100 million at 7.5%
interest, but actually needs an equivalent
amount in dollars, $150 million to finance its
new refining facility in the U.S.

Also, suppose that the Piper Shoe Company, a U.

S. company, plans to issue $150 million in bonds
at 10%, with a maturity of five years, but it
really needs £100 million to set up its
distribution center in London.
 Example Contd.

To meet each other's needs, suppose that both

companies go to a swap bank that sets up the
following agreements:
 Example Contd.
Agreement 1:
1. The British Petroleum Company will issue 5-year £100
million bonds paying 7.5% interest. It will then
deliver the £100 million to the swap bank who will
pass it on to the U.S. Piper Company to finance the
construction of its British distribution center.

2. The Piper Company will issue 5-year $150 million

bonds. The Piper Company will then pass the $150
million to swap bank that will pass it on to the British
Petroleum Company who will use the funds to finance
the construction of its U.S. refinery.
 Example Contd.
Agreement 2:
1. The British company, with its U.S. asset will
pay the 10% interest on $150 million to the
swap bank who will pass it on to the American
company so it can pay its U.S. bondholders.

2. The American company, with its British asset

will pay the 7.5% interest on £100 million to
the swap bank who will pass it on to the
British company so it can pay its British
bondholders.
Determinants of Foreign
Exchange
 Foreign Exchange

The system of converting one national

currency into another, or of transferring
money from one country to another.
 Determinants

Long–term Factors Short-term Factors

Determinants

Long-Term Factors
 Inflation Rate
A higher rate of inflation will make a
country’s currency less attractive
because of the loss of real value with
inflation.

◦ Hence, that currency would depreciate

against major currencies.
 Interest Rate
 Changes in interest rate affect currency
value and dollar exchange rate. Forex rates,
interest rates, and inflation are all
correlated.
 Increases in interest rates cause a country's
currency to appreciate because higher
interest rates provide higher rates to
lenders, thereby attracting more foreign
capital, which causes a rise in exchange
rates.
 Balance of Payments
A deficit in balance of payments of a country
due to spending more of its currency on
importing products than it is earning through
sale of exports causes depreciation. Balance of
payments fluctuates exchange rate of its
domestic currency.
 Money Supply

An increase in money supply will affect the

exchange rate through causing inflation in the
country. It can also affect the exchange rate
directly in the short run.
 National Income

An increase in the national income will lead to

an increase in investment or in consumption
and accordingly, its effect on the exchange
rate will change.
Determinants

Short-Term Factors
 Political Factors

Factors like war. Announcement of election

results, oil price increase etc. will cause
exchange rate fluctuations.
 Central Bank Intervention

Buying and selling of foreign currency in the

market by the Central Bank with a view to
increasing the supply or demand, there by
affecting the exchange rate, is known as
intervention.
 Foreign Investment Flow

Both foreign direct and portfolio investment

inflows and outflows affect the exchange
rates.
 Speculation
If a country's currency value is expected to
rise, investors will demand more of that
currency in order to make a profit in the near
future. As a result, the value of the currency
will rise due to the increase in demand. With
this increase in currency value comes a rise in
the exchange rate as well.
Difference between
Future & Forward
Contract
 Forward Contract

A forward contract is a customized

contractual agreement where two private
parties agree to trade a particular asset with
each other at an agreed specific price and
time in the future. Forward contracts are
traded privately over-the-counter, not on an
exchange.
 Future Contract
A futures contract — often referred to as
futures — is a standardized version of a
forward contract that is publicly traded on a
futures exchange.

Like a forward contract, a futures contract

includes an agreed upon price and time in the
future to buy or sell an asset — usually stocks,
bonds, or commodities, like gold.
 Major Difference
The main differentiating feature
between futures and forward contracts
— that futures are publicly traded on an
exchange while forwards are privately
traded — results in several operational
differences between them.
 Difference
Forward Future

Customized to customer Standardized. Initial

Structure & Purpose needs. Usually no initial margin payment
payment required. required.

Negotiated directly by Quoted and traded on

Transaction method
the buyer and seller the Exchange

Government regulated
Market regulation Not regulated
market

Risk High counterparty risk Low counterparty risk

 Difference
No guarantee of settlement
until the date of maturity Both parties must deposit
Guarantees only the forward price, an initial guarantee
based on the spot price of (margin).
the underlying asset is paid

Forward contracts generally Future contracts may not

Contract Maturity mature by delivering the necessarily mature by
commodity. delivery of commodity.

Depending on the
Expiry date Standardized
transaction
 Difference
Opposite contract with
same or different
Method of pre- counterparty. Counterparty Opposite contract on the
termination risk remains while exchange.
terminating with different
counterparty.

Depending on the
transaction and the
Contract size Standardized
requirements of the
contracting parties.

Market Primary & Secondary Primary

Concept of Options &
Risk Management
 Options

An option is a financial contract that gives an

investor the right, but not the obligation, to
either buy or sell an asset at a pre-determined
price (known as the strike price) by a specified
date (known as the expiration date).
 Explanation
Options are derivative instruments, meaning that their
prices are derived from the price of their underlying
security, which could be almost anything: stocks,
bonds, currencies, indexes, commodities, etc.

There are two types of options: call options and put

options. A buyer of a call option has the right to buy
the underlying asset for a certain price. The buyer of a
put option has the right to sell the underlying asset for
a certain price.
 Example
In a simple call options contract, a trader may expect
Company XYZ's stock price to go up to $90 in the next
month. The trader sees that he can buy an options
contract of Company XYZ at $4.50 with a strike price
of $75 per share. The trader must pay the cost of the
option ($4.50 X 100 shares = $450). The stock price
begins to rise as expected and stabilizes at $100. Prior
to the expiry date on the options contract, the trader
executes the call option and buys the 100 shares of
Company XYZ at $75, the strike price on his options
contract. He pays $7,500 for the stock. The trader
can then sell his new stock on the market for $10,000,
making a $2,050 profit ($2,500 minus $450 for the
options contract).
 Risk Management

Risk Management deals with the identification,

assessment and various strategies that help mitigate
the adverse effects of risk on the organization.
Management uses risk management as a strategic tool
to mitigate the loss of property and increase the
success chance of the organization.
 Enterprise Risk Mang.

It is a strategic framework that checks the potential

risks that have adverse impacts over the enterprise.
These risks could be in terms of risk related to
resources , product and services or the market
environment in which the enterprise operates.
Enterprises develop risk management capabilities to
deal with these risks and a proper action plan.
 Operational Risk Mang.

Operational risks are present in every enterprises.

These risks arise due to the execution of the business
functions of the enterprises. Enterprises need to assess
these risks and prepare action plans to meet the
impact of risk.
 Operational Risk Mang.
At the primary level, operational risk management
deals with technical failures and human errors like:

Mistakes in execution
System failures
Policy violations
Legal infringements
Rule breaches
Indirect and direct additional risk taking
 Financial Risk Mang.
The process of financial risk management can be
defined as minimizing exposure of a firm to market
risk and credit risk using various financial instruments.
Financial risk managers also deal with other risks
related to foreign exchange, liquidity, inflation, non-
payment of clients and increased rate of interest.
These risks affect the financial position of the
enterprise.
 Market Risk Mang.

Enterprises need to understand the risks present in the

market , inherent to the industry or arising out of
competition. Enterprise need to properly assess it and
develop their capabilities . It Deals with different
types of market risks, such as interest rate risk, equity
risk, commodity risk, and currency risk.
 Credit Risk Mang.

Managing credit risk is one of the fundamental work of

the financial institution. Credit portfolio management
is largely becoming essential for the enterprise to
keep track of risk. It Deals with the risk related to the
probability of nonpayment from the debtors.
Commodity Risk Mang.

It Handles different types of commodity

risks, such as price risk, political risk,
quantity risk and cost risk.
 Quantitative Risk Mang.

In quantitative risk management, an effort is carried

out to numerically ascertain the possibilities of the
different adverse financial circumstances to handle
the degree of loss that might occur from those
circumstances.
 Integrated Risk Mang.

Integrated risk management refers to integrating risk

data into the strategic decision making of a company
and taking decisions, which take into account the set
risk tolerance degrees of a department. In other
words, it is the supervision of market, credit, and
liquidity risk at the same time or on a simultaneous
basis.
 Technology Risk Mang.

It is the process of managing the risks

associated with implementation of new
technology.
Risks Associated with
Forex
 Risks associated with Forex
Foreign-exchange risk refers to the potential for loss
from exposure to foreign exchange rate fluctuations.

Foreign-exchange risk is the risk that an asset or

investment denominated in a foreign currency will lose
value as a result of unfavorable exchange rate
fluctuations between the investment's foreign currency
and the investment holder's domestic currency.
 Transaction Risk
Transaction risks are an exchange rate risk associated
with time differences between the beginning of a
contract and when it settles.

currencies may be traded at different prices at

different times during trading hours. The greater the
time differential between entering and settling a
contract increases the transaction risk.
 Interest Rate Risk
If a country’s interest rates rise, its currency will
strengthen due to an influx of investments in that
country’s assets putatively because a stronger
currency provides higher returns.

Conversely, if interest rates fall, its currency will

weaken as investors begin to withdraw their
investments.

Due to the nature of the interest rate and its

circuitous effect on exchange rates, the differential
between currency values can cause forex prices to
dramatically change.
 Leverage Risk
In forex trading, leverage requires a small initial
investment, called a margin, to gain access to
substantial trades in foreign currencies. Small price
fluctuations can result in margin calls where the
investor is required to pay an additional margin.
During volatile market conditions, aggressive use of
leverage will result in substantial losses in excess of
initial investments.
 Counterparty Risk
The counterparty in a financial transaction is the
company which provides the asset to the investor.
Thus counterparty risk refers to the risk of default
from the dealer or broker in a particular transaction.

In forex trades, spot and forward contracts on

currencies are not guaranteed by an exchange or
clearing house. In spot currency trading, the
counterparty risk comes from the solvency of the
market maker. During volatile market conditions, the
counterparty may be unable or refuse to adhere to
contracts.
 Country Risk
When weighing the options to invest in currencies, one
must assess the structure and stability of their issuing
country. In many developing and third world countries,
exchange rates are fixed to a world leader such as the
US dollar.

In this circumstance, central banks must sustain

adequate reserves to maintain a fixed exchange rate.
A currency crisis can occur due to frequent balance of
payment deficits and result in devaluation of the
currency. This can have substantial effects on forex
trading and prices.
Pakistan Mercantile
Exchange Limited
 PMEX
Commodity Trading was introduced in Pakistan in 2007
by Pakistan Mercantile Exchange Limited and since
then, a new era of investments is emerged in the
region.

Though local investors had been trading in

commodities internationally, PMEX is the first to bring
commodity trading here potentially.

The institute is licensed and regulated by Securities

and Exchange Commission of Pakistan. PMEX has a
promising goal to make commodity trading, an easy
investment venue for the investors. Thus, PMEX has
brought in technologies and support to make
commodity trading available to locals.
 Highlights of PMEX
 National institution and the only platform that offers
commodity futures trading in Pakistan

 Broker network of 329 members

 In-house developed web based trading platform

 21 hours market timing - working towards 23.5 hours market

 Aggressively focusing on the market development and client

awareness programs along with increasing the product
offerings to the investors

 End to end solution - trading, clearing & settlement, custody

and back office
 PMEX
PMEX has most of the institutional shareholdings:

Shareholder Shares Held % Holding

National Bank of Pakistan Limited 10,653,860 33.98%
Pakistan Stock Exchange Limited 8,909,052 28.41%
ISE Towers REIT Management Limited 5,568,181 17.76%
LSE Financial Service Limited 2,272,727 7.25%

Pak Brunei Investment Company Limited 2,133,115 6.80%

Zarai Taraqiati Bank Limited 909,091 2.90%

Pak Kuwait Investment Company Limited 909,090 2.90%

Individuals 46 0.0001%
Total 31,355,162 100.00%
 Commodities Listed
The commodities listed with PMEX are
gold, silver, cotton, crude oil, palm,
rice, sugar, wheat and red chili. The
investor also has an option of trading in
futures. No doubt it is a great
investment to make your savings into
bundles.
 Basic Function

The fact is that PMEX is and has been a Futures

Exchange. PMEX is neither in competition with,
nor is an alternative to spot markets. Being a
Futures Exchange, PMEX's prime role is to
develop forward and hedge markets in various
commodities including domestic agriculture
products.
 PMEX Commodity Murabaha
An Efficient Liquidity Management Tool for the Islamic Finance Industry

 PMEX has developed a Murabaha product to

facilitate the Islamic Finance Industry (IFI)

 International commodity exchanges such as London

Metal Exchange, Bursa Malaysia & Jakarta Futures
Exchange are also enabling Murabaha transactions
and are acting as hubs for Islamic Banking liquidity
management

 PMEX regulated platform will serve as an industry

standard, efficient liquidity management solution
Role in Agriculture
 Pakistan’s GDP is USD 250 billion

 Agriculture contributes around 22% in GDP and

45% in employment

 Major crops are: Cotton, Wheat, Sugarcane, Rice

and Maize

 For Cotton Pakistan is amongst top five and for

Wheat, Sugarcane and Rice Pakistan is amongst
top ten countries.

 PMEX aims to bring futures contracts of all the

above commodities on its trading platform
 Investment plan of
Insurance Companies
 State Life Investment
Investments
State Life Insurance Corporation of Pakistan invests its funds in
accordance with the provisions contained in Insurance Ordinance
2000, Insurance Rules 2002 and SRO(309) K of 1970 as amended to
date by the Government of Pakistan.
Govt. Securities
These include instruments issued by Government of Pakistan such
as Treasury bills, Pakistan Investment Bonds etc.
Approved Govt. Securities
These include instruments as Wapda Bonds, Provincial
Securities/TFCs etc.
 State Life Investment

Loans
These include loans in the form of Term finance
certificates etc.
Equities
These include shares of listed and unlisted companies.
Immovable Property
These include buildings, plots etc.
 State Life Insurance Co.

SLIC’s investments are government

securities (67%), corporate debts (1%),
Equities (9%), Investment property (1%),
Bank deposits (10%), Loans against
policies (8%) and other assets (4%)
Investment Plan
State Life Investment

As at 31-12-2015
(Rs. in millions)
Particulars Portfolio
Govt. Securities 413,233
Other Fixed Income Securities 860
Equities and Mutual Funds
Bank Deposits 13,442
Investment properties 2,949
Policy Loans 50,673
513,293
EFU Investment Plan
EFU Investment Plan

As at 31-12-2015
(Rs. in millions)
Particulars Portfolio
Govt. Securities 492,515
Other Fixed Income Securities 143
Equities and Mutual Funds 2125
Bank Deposits 1440
Unlisted Equity Securities 0.5
EFU Investment Policy

The EFU Investment Plan is a regular premium

unit linked Endowment Assurance plan. The
benefits of the plan are largely linked to the
value of the investments of the EFU Managed
Growth Fund in which a proportion of the
premium is invested.
EFU Investment Policy
The minimum premium for the basic plan is Rs.11,000 p.a. The
proportion of premium allocated for investment varies by policy year
and is as follows:
EFU Investment Policy
If the annual basic plan premium is over Rs.20,000. In the first year
the allocation varies by the term of the plan as follows:
EFU Investment Policy

The remaining portion of the premium is

used to meet expenses, the lower
allocation in earlier years reflecting the
higher initial expenses.