FMS_FINAL NA PDF - Securities Firms & Investment Banks

OTHER KINDS OF FINANCIAL INSTITUTIONS: SECURITIES FIRMS & INVESTMENT BANKS INVESTMENT COMPANIES PENSION FUNDS *Securities Firms & Investment Banks *Investment Companies *Pension Funds SECURITIES FIRMS (STOCK) A company that facilitates financial market...

OTHER KINDS OF FINANCIAL INSTITUTIONS: SECURITIES FIRMS & INVESTMENT BANKS INVESTMENT COMPANIES PENSION FUNDS *Securities Firms & Investment Banks *Investment Companies *Pension Funds SECURITIES FIRMS (STOCK) A company that facilitates financial market trades between buyers and sellers for a fee. Includes firms whose principal lines of business are in securities brokerage. financial advisory services, investment banking and/or securities trading Securities firms include investment banks, investment companies and brokerage firms. They serve as financial intermediaries in various ways First. They play an investment banking role by placing securities (stocks and debt securities) issued by firms or government agencies. That is, they find investors who want to purchase these securities. Second, securities firms serve as investment companies by creating, marketing, and managing investment portfolios. Finally, securities firms play a brokerage role by helping investors purchase securities or sell securities that they previously purchased. 1. Trading securities 2. Investment portfolio - compilation of your financial asset SECURITIES FIRMS CAN BE: a. Brokerage Firm (brokerage) - a stock broker's business; charges a fee to act as intermediary between buyer and seller. b. Bucket Shop - an unethical or overly aggressive brokerage firm. -nangyayari ang "bucketing" ( execute fake trades) price movement c. Non-depository Financial Institution - a financial institution that funds their investment activities from the sale of securities or insurance. -More on tradings THE BROKER, DEALER AND BROKER- DEALER OF SECURITIES Broker is an individual or a firm that conduct securities transactions on the part of their clients buying, selling or trading for the investment portfolio of their clients (a) (AGENT) Dealers are people or organizations that buy or sell securities of their own portfolio (own account) and then deal those securities to customers who are looking to buy them (p) (PRINCIPAL) Broker-dealers are organizations that do a combination of both of these services. They perform pretty much all the middle-man functions of providing securities services to corporations and individuals alike, and they've all but eliminated the need for organizations that specialize in either broker or dealer services A special type of broker, called a discount broker performs similar functions as broker-dealers, except that they only perform the transactions, while broker-dealers often provide assistance by offering advice analysis and other services that can help their customers make investment decisions. Discount brokers don't perform these additional services TOP 5 BEST STOCK BROKERS IN THE PHILIPPINES: COL Financial - CitiSecOnline First Metro Sec. - First Metro Securities BDO Securities - Banco De Oro Securities BPI Trade - Bank of the Philippine Islands Trade Philstocks - Philippine Stock Exchange, Inc. INVESTMENT BANKS An investment bank is a special type of financial institution that aims to help companies access capital markets to raise money and take care of other business needs. A typical investment bank will engage in some or all of the following activities: Raise equity capital, Raise debt capital, Insure bonds or launching new products. INVESTMENT BANKING - Organize large and complex financial transaction Mergers - combination of two entities acquisition - binibili ng larger entity ang isa pang entity HOW INVESTMENT BANK WORKS? Investment banks are often divided into two camps, the buy-side and sell-side, but many offer both buy-side and sell-side services. The sell-side typically refers to selling shares of newly issued IPOs, placing new bond Issues, engaging in market-making services, or helping clients facilitate transactions. In contrast, the buy-side works with pension funds, mutual funds, hedge funds, and the investing public to help them maximize their returns when trading or investing in securities such as stocks and bonds. What is the difference between investment banks and commercial banks? INVESTMENT BANKS VS COMMERCIAL BANKS INVESTMENT BANK Investment Bank Doesn't accept deposits Doesn't provide loans Targets larger corporations and high net worth individuals Regulated by the country's security agency COMMERCIAL BANK Commercial Bank Accepts deposits Provides loans Targets all consumers, small to large size corporations, and governments Regulated by the country's central bank THE PRIMARY DIFFERENCE BETWEEN INVESTMENT AND COMMERCIAL BANKS IS INVESTMENT BANKS Investment banks focus on helping businesses access capital markets COMMERCIAL BANKS Commercial banks primarily deal with deposit accounts and loans for individuals and companies HERE IS THE LIST OF TOP INVESTMENT BANKS IN THE PHILIPPINES ABCapital Inc. Asian Alliance Investment Corporation Asian Focus Group Inc. BPI Capital Corporation Eastgate Capital Partners, Inc. First Abacus Financial Holdings Corporation First Metro Investment Corporation FSG Capital Inc. Insular Investment & Trust Corporation Investment & Capital Corporation of the Philippines Mabuhay Capital Corporation, Inc. Medco Holdings, Incorporated Navarro Amper & Co PNB Capital and Investment Corporation Punongbayan & Araullo SB Capital Investment Corporation Unioil Resources & Holdings Company, Inc SERVICES OFFERED BY SECURITIES FIRMS VS INVESTMENT BANKS HOW SECURITIES FIRMS DIFFER FROM INVESTMENT BANKS? IN WHAT WAYS ARE THEY FINANCIAL INTERMEDIARIES? SECURITIES FIRMS AND INVESTMENT BANKS ACTIVITY AREAS: Investing Investment banking Market making Trading Cash management Mergers & acquisitions  INVESTMENT COMPANIES WHAT IS INVESTMENT COMPANIES? An investment company is a corporation or trust engaged in the business of investing the pooled capital of investors in financial securities.Thus is most often done either through a closed-end fund or an open-end fund. An investment company is also known as “Fund Company” or “Fund sponsor”. They often partner with third party distributors to sell mutual funds Cater several individual to investor Pull in capital/funds TYPES OF INVESTMENT COMPANIES MAJOR TYPES OPEN-END INVESTMENT COMPANIES These companies raise capital through issues of shares.which are not traded on stock exchange,but handled by specified dealer in over-the-counter transactions.The money obtained from the sale of shares is invested directly in the shares of other companies.Usually,no leverage occurs in the open-end-fund,unless the company can borrow money to invest ,as some companies do. RAISE THROUGH ISSUE OF SHARES CONTINUOUS ISSUANCE OF SHARES SIMILAR TO SELL SIDE MUTUAL FUNDS 1. INVESTORS - POOL THEIR MONEY TOGETHER 2. FUND MANAGERS - CHOOSE SECURITIES TO INVEST IN 3. SECURITIES - GENERATES 4. RETURNS - PASS DOWN TO INVESTORS CLOSED-END INVESTMENT COMPANIES These companies operate in much the same fashion as any industrial Company. It issues a fixed number of shares,which may be listed on a stock exchange and bought and sold like any company's shares. If the management desires, it might revise additional equity issues,bonds or preferred stock issues. Majority of such companies have bonds and preferred stocks outstanding as a part of their capital structure. FIXED SHARES / FIXED NUMBER OF SHARES MINOR (HONORABLE MENTION) UITS A Unit Investment Trust (UIT) is an investment company that offers a fixed portfolio,generally of stocks and bonds,as redeemable units to investors for a specific period of time. It is designed to provide Capital Appreciation and or dividend income. Unit Investment trusts,along with Mutual funds and closed-end funds are defined as investment companies. THEY HAVE DEFINED LIFE SPAN FIXED PORTFOLIO DOES NOT REALLY CHANGE EXAMPLE OF INVESTMENT COMPANIES IN THE PHILIPPINES LOAN STAR LENDING GROUP CORPORATION - FOCUS ON OFW MOSTLY SA SEAFARERS CARITAS FINANCIAL PLAN INCORPORATED - CATER PENSION FUNDS OSG GLOBAL CONSULTING INCORPORATED - CATER INDIVIDUALS INVOLVES IN CORPORATION DS FINANCE CORPORATION - CATER PENSION FUNDS VIGATTIN INSURANCE - NON LIFE INSURANCE (REAL ESTATE, CARS ,HOUSE ETC.) PENSION FUNDS WHAT IS PENSION FUND? A Pension Fund is any plan fund or scheme that provide retirement income pension funds are pooled monetary contributions from pension plans set by employers,unions,or other pension payment are determined by the length of the employees working years and the annual income they earned on the job leading up to retirement pension funds typically aggregate large sums of money to be invested into the capital markets,such as stock and bonds markets to generate profit (returns). The main goal of a pension fund is to ensure there will be enough money to cover the pensions of employees after their retirement in the Future. CAPITAL MARKET —-> STOCK AND BONDS METHOD OF PAYMENT PENSION FUNDS DIFFER IN METHOD OF PAYMENT ALTHOUGH THE PURPOSE REMAINS THE SAME THE FIRST METHOD OF PAYMENT - KNOWN AS DEFINED BENEFIT PLAN - GUARANTEE PAYMENTS OF BENEFITS THAT ARE NOT TIED TO CONTRIBUTIONS BUT BASED ON A PRESCRIBED FORMULA UNDER THIS TYPES OF PLAN THE SPONSOR SHOULDERS RISK OF SHORTFALL IN INVESTMENT RETURNS  SHOULDER RISK EMPLOYER (GUARANTEED THE EMPLOYEE WILL BENEFIT) THE OTHER TYPE OF PLAN - DEFINED CONTRIBUTIONS PLAN- BOTH EMPLOYEE AND THE EMPLOYER CONTRIBUTE SPECIFIC AMOUNTS TO THE PLAN PERIODICALLY UNDER THE DEFINED CONTRIBUTION PLAN THE EMPLOYEE BEAR THE RISK OF ACCUMULATED FUNDS NOT MEETING REPLACEMENT INCOME GOAL EMPLOYEE BEAR THE RISK BUT THERE STILL A CONTRIBUTION OF EMPLOYER MAINLY USED IN THE PHILIPPINES HOW A PENSION FUND WORKS? A PENSION PLAN IS MODELED AFTER A TRADITIONAL LONG-TERM RETIREMENT SAVINGS PLAN WHERE A COMPANY SETS ASIDE A FIXED PERCENTAGE OF THE EMPLOYEES SALARY IN A RETIREMENT SAVINGS ACCOUNT AND INVEST THE ACCOUNT PROCEEDS ON THE WORKERS BEHALF OVER THE YEARS THOSE ASSETS (USUALLY INVESTED IN STOCKS,BONDS AND FUNDS) APPRECIATE AND GROW PROVIDING THE EMPLOYEE (HOPEFULLY) AN AMPLE INCOME SOURCE DURING RETIREMENT TYPICALLY,UPON RETIREMENT THE EMPLOYEE CAN CHOOSE TO RECEIVE THOSE PENSION BENEFITS AS A LUMP SUM OR IN A SERIES OF STEADY,ANNUITY LIKE PAYMENTS THROUGH THE COURSE OF HE OR HER RETIREMENT PAYOUT LUMP SUM - ISANG BAGSAKAN STEADY ANNUITY PAYMENT - MONTHLY NA MAY NATATANGGAP PENSION PLAN ARE CALCULATED BASED ON THREE CRITERIA: THE EMPLOYEES YEARS OF SERVICE AT A SPECIFIC COMPANY OR ORGANIZATION THE EMPLOYEES AGE THE EMPLOYEES ANNUAL COMPENSATION TWO TYPES OF PENSION FUNDS PRIVATE PENSION FUNDS - Social Security System PUBLIC PENSION FUNDS - Government Service Insurance System (GSIS) The Government Service Insurance System (GSIS) and the Social Security System serve as the largest pension funds in the Philippines. These two government administered funds invest in government securities,the stock market, commercial paper and property development. Their income usually comes from salary and housing loans ,interest income in investments, dividends and foreign exchange gains.Apart from GSIS And SSS, there is another smaller government-administered fund, the Armed Forces of the Philippines Retirement Separation and Benefits System (AFP-RSBS). These three public pension funds all fall under, mandatory defined benefit plan. PRIVATE EMPLOYEE - CAN’T ACQUIRE GSIS PUBLIC EMPLOYEE - CAN ACQUIRE SSS AND GSIS GOVERNMENT EMPLOYEES ( MILITARY,POLICE ETC) - CAN ACQUIRE THE THREE PENSION FUNDS SUMMARY Securities Firms provide transaction service related to financial Investments. A securities firm serve as financial intermediaries in various ways. It includes investment banks, investment companies and brokerage firms Investment Bank is a special type of financial institutions that aims to help companies access capital markets to raise money and take care of other business needs. An Investment banks are divided into two camps: the buy side and sell side services. Investment Companies is a corporation or trust engaged in the business of investing the pooled capital of investors in financial securities. An Investments companies is also known as "fund company" or "Tund sponsor" There are three types of Investment Companies: Open-end, Closed-end Investment Company and Unit Investment Trust (UIT). A pension fund is a pool of money that is to be paid out as a pension when employees retire Pension funds invest that money to multiply it, which will potentially provide more benefit to the retirees Pension payout amounts are dependent on the percentage of the average salary of an employee for the last few years of their employment RISK INCURRED BY FINANCIAL INSTITUTIONS FINANCIAL RISK DEFINITION (danger,threats,problem) Financial risk is the possibility of losing money on an. Investment or business venture. ★ Money —-> losses ★ Internal - ex, internal breaches , heist ★ External - natural disaster ★ Default - tendency of bankruptcy > RISK MITIGATION - broader approach > RISK REDUCTION - form of risk mitigation > RISK AVOIDANCE - minimal , may limitation Financial markets face financial risk due to various macroeconomics forces,changes to the market interest rate,and the possibility of default by sectors or large corporations. For the governments,this can mean they are unable to control monetary policy and default on bonds or other debt issues. Corporations also face the possibility of default on debt they undertake but may also experience failure in undertaking the causes of a financial burden on the business. WHY RISK MATTERS Because taking risk is an integral part of the banking business,it is not surprising that banks have been practicing risk management ever since there have been banks - the industry could not have survived without it. The only real change is the degree of sophistication now required to reflect the more complex and fast paced environment. Risk can come from both internal and external sources.The external risk are those that are not in direct control of the management. These include political issues, exchange rates,interest rates,and so on.Internal risks,on the other hand, include non-compliance or information breaches,akong several others. “KNOWING THE DANGERS AND HOW TO PROTECT YOURSELF WILL NOT ELIMINATE THE RISK,BUT IT CAN MITIGATE THEIR HARM” (STRATEGIES)-->)RISK MANAGEMENT – COUNTER ATTACK THE RISK OF THE BUSINESS RISK MITIGATION Risk mitigation is a strategy to prepare for and lessen the effects of threats faced by a business. Comparable to risk reduction,risk mitigation takes steps to reduce the negative effects of threats and disasters on business continuity (BC). Threats that might put a business at risk include cyberattacks,weather events and other causes of physical or virtual damage.Risk mitigation is one element of risk management and it's implementation will differ by organization DIFFERENCE RISK MITIGATION - STRATEGY PREPARE AND LESSEN THE RISK (BROADER APPROACH) RISK REDUCTION - SUBSEQUENT FORM OF RISK MITIGATION TECHNIQUE RISK AVOIDANCE - DIVERSIFY PORTFOLIO / HANDS ON LEVEL APPROACH FINANCIAL RISK Pros  Encourages more informed decisions Helps asses value (risk-reward ratio) Can be identified using analysis tools Cons Can arise from uncontrollable or unpredictable outside forces Risk can be difficult to overcome Ability to spread and affect entire sectors or markets RRR or RISK REWARD RATIO (optimal ratio) ↓ ↓ ↓ Losses gains Calculation RISK REWARD RATIO- CALCULATE POTENTIAL LOSSES AND GAIN HOW CAN A FIRM MITIGATE RISK? / RISK MANAGEMENT TECHNIQUES 1. Eliminate or avoid risk by simple business practices Risk avoidance involves reducing the chances of losses by eliminating risks that are unnecessary to the institution’s business purposes. Common risk-avoidance activities are underwriting standards,hedges or asset-liability matches, diversification and due diligence investigation. 2. Transfer risk to other participants Individual market participants can buy or sell financial claims to diversify or concertante the risk in their portfolios to the extent that the market understands the financial risks of the assets that the firm creates or holds,the assets can be sold in the open market at their fair market value. 3. Actively manage risk at the firm level The firm should absorb another class of assets or activities in which the risk is inherit. In these cases,risk management must be aggressive,and there must be good reason for using further resources to manage firm level risk Firm level - hands on approach Intrinsic - True value ( did not considering the market value) TOOLS TO CONTROL FINANCIAL RISK The most common methods that invest professionals use analyze risk associated with long term or the stock market as a whole include :  1. Fundamental analysis - the process of measuring a security’s intrinsic value by evaluating all aspects of the underlying business including the firm's assets and its earrings. 2. Technical analysis - the process of evaluating securities through statistics and looks at historical returns, trade volume, share prices, and other performance data HISTORICAL AND PREVIOUS DATA 3. Quantitative analysis - the evaluation of the historical performance of a company using specific financial ratio calculations. ASSESSING TROUGH QUANTITY (INTERNAL) TYPES OF FINANCIAL RISKS CREDIT RISK LIQUIDITY RISK INTEREST RATE RISK MARKET RISK CREDIT RISK A credit risk occurs when there is potential that a borrower may default or miss on an obligation as stated in a contract between the financial institution and the borrower. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk will be associated with higher borrowing costs. Because of this, measures of borrowing costs such as yield spreads can be used to infer credit risk levels based on assessments by market participants. Losses can arise in a number of circumstances, A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit, or other loan. A company is unable to repay asset-secured fixed or floating charge debt. A business or consumer does not pay a trade Invoice when due. A business does not pay an employee's earned wages when due. A business or government bond issuer does not make a payment on a coupon or principal payment when due. An insolvent insurance company does not pay a policy obligation. An insolvent bank won't return funds to a depositor. Floating charge debt/ floating lier- Type of security interest that allow a lender to claim collateral that may change in quantity and value overtime ( non-constant asset) Payback period - initial project cost The Five Cs of Credit The five Cs of credit is a system used by lenders to gauge the creditworthiness of potential borrowers. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of default and, consequently, the risk of a financial loss for the lender. 5 C's of credit (not required nor mandated) 1. Character Although it's called character, the first C more specifically refers to credit history: a borrower's reputation or track record for repaying debts. This information appears on the borrower's credit reports CHARACTER/ Credit history ( nalalaman if good or bad payer) 1. Educational background 2. Work employment history 3. Calling personal or business reference 4. Personal interview of borrower 5. Credit history score (Acquire through loans) 2. Capacity Capacity measures the borrower's ability to repay a loan by comparing income against recurring debts and assessing the borrower's debt-to-income (DTI) ratio, Lenders calculate DTI by adding together a borrower's total monthly debt payments and dividing that by the borrower's gross monthly income. The lower an applicant's DTI, the better the chance of qualifying for a new loan. Every lender is different, but many lenders prefer an applicant's DTI to be around 35% or less before approving an application for new financing. CAPACITY -Debt-to-income (DTI) ratio -DTI = Monthly debt / gross monthly income -35% or less optimal ratio -43% ( bahay/lupa) 3. Capital Lenders also consider any capital the borrower puts toward a potential investment. A large contribution by the borrower decreases the chance of default 4. Collateral Collateral can help a borrower secure loans. It gives the lender the assurance that if the borrower defaults on the loan, the lender can get something back by repossessing the collateral. COLLATERAL - property pledge asset ex. Property bonds house 5. Conditions The conditions of the loan, such as its interest rate and amount of principal, influence the lender's desire to finance the borrower. Conditions can refer to how a borrower intends to use the money. Consider a borrower who applies for a car loan or a home improvement loan. A lender may be more likely to approve those loans because of their specific purpose, rather than a signature loan, which could be used for anything. CONDITION Personal/ signature (hindi sinasabi kung para saan ) TYPES OF CREDIT RISK 1. Credit default risk-The risk of loss arising from a debtor being unlikely to pay its loan obligations in full or the debtor is more than 90 days past due on any material credit obligation; default risk may impact all credit-sensitive transactions, including loans, securities and derivatives. The Easiest risk 2. Concentration risk-The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations. It may arise in the form of single-name concentration or industry concentration. Highlight and focus more in the firm's Single name concentration (Directly affiliated with the firm) (Focus on one company) EX. BDO —-> SM Industry concentration (Cater particularly some industry) mas malawak Ang sakop kumpara sa single name concentration 3. Country risk-The risk of loss arising from a sovereign state freezing foreign currency payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk); this type of risk is prominently associated with the country's macroeconomic performance and its political stability. less likely to happen  Economic counter (Gera, economic turmoil) WAYS TO MITIGATE CREDIT RISK 1. Risk-based pricing-Lenders may charge a higher interest rate to borrowers who are more likely to default, a practice called risk-based pricing. Lenders consider factors relating to the loan such as loan purpose, credit rating, and loan-to-value ratio and estimates the effect on yield (credit spread). Mas mataas Ang interest kapag BAD PAYER Ang customer 2. Covenants-Lenders may write stipulations on the borrower, called covenants, into loan agreements, such as: Periodically report its financial condition, Refrain from paying dividends, repurchasing shares, borrowing further, or other specific, voluntary actions that negatively affect the company's financial position, and Repay the loan in full, at the lender's request, in certain events such as changes in the borrower's debt-to-equity ratio or interest coverage ratio. - COVENANT (PWEDE MONG GAWIN O HINDI MO PWEDENG GAWIN) 3. Credit insurance and credit derivatives- Lenders and bond holders may hedge their credit risk by purchasing credit insurance or credit derivatives. These contracts transfer the risk from the lender to the seller (insurer) in exchange for payment. The most common credit derivative is the credit default swap. Transfer the risk from the insurance 4. Tightening-Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers. For example, a distributor selling its products to a troubled retailer may attempt to lessen credit risk by reducing payment terms from net 30 to net 15. GINIGIPIT ANG BORROWER 5. Diversification-Lenders to a small number of borrowers(or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk. Lenders reduce this risk by diversifying the borrower pool. DAPAT MARAMI ANG KLASE NG BORROWER (FARMERS,EMPLOYEE) 6. Deposit insurance-Governments may establish deposit Insurance to guarantee bank deposits in the event of insolvency and to encourage consumers to hold their savings in the banking system instead of in cash.  LIQUIDITY RISK Liquidity risks refers to the ability of a bank to access cash to meet funding obligations Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result In a snowball effect. Snowball effect - is a situation in which something increases in size at a faster rate. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank's ability to provide funds and leads to a bank run. Bank run- withdraw their money on the bank (bulk)(madami Ang nag withdraw na tao) Reputation risk - affect the name of the company Liquidity risk are financial risks that a given asset cannot be traded quickly enough to prevent a loss or expected profit Assets like stocks and bonds are very liquid since they can be converted to cash within days. However, large assets such as property, plant, and equipment are not as easily converted to cash. Liquidity asset - bond,stocks (mabilis na mabenta ) mabilis ma convert sa cash I-liquid asset - real estate ,property, equipment (matagal na mabenta) Hindi mabilis ma convert sa cash Adequate liquidity is dependent upon the institution's ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or the financial condition of the institution. Adequate liquidity -sufficient and enough funds to cover the liquidation TYPES OF LIQUIDITY RISK 1. Asset liquidity This is where an asset cannot be sold in the market when you want to sell it. This is most common with houses where depressed conditions put a stop on demand and pushes away buyers. Nag try mabenta pero Hindi agad nabebenta Kung mabenta mo man yung (property) Bahay magkakaron kaparin ng losses. Also called market Liquidity 2. Funding liquidity This is where one does not have enough money to pay off a loan when it comes due. This may be because the borrower's money is stuck somewhere else. Walang enough na fund para ma settle Ang short term obligation Similar to credit risk The money is stock with someone else Reasons Fi face liquidity problems Over-reliance on short-term sources of funds. - Concentrate in short term Having a balance sheet concentrated in illiquid assets. - Meron dapat sa short term and long term balance dapat Loss of confidence in the bank on the part of customers. - bankruptcy Mismanagement of asset-liability duration can also cause funding difficulties. This occurs when a bank has many short term liabilities and not enough short-term assets - Meron na How is Market liquidity risk measured? (ASSETS) Market Liquidity risk is measured in three ways. depth, width, and resilience. 1. Depth The depth of a market is a measure of the volume of securities being treated- and the effect that orders have on market price If a market is "deep" there are many shares being traded A large order would not have a significant effect on the market price - Wala masyadong changes - Maraming na transact na securities If a market is "shallow" there are fewer shares being traded. A large onder would have a significant effect on the market price. - 2. Width The width of a market refers to the bid-ask spread, which is the difference between the offer price and the asking price of an asset If the gap is "wide" there is a big difference between the price that sellers are asking and the price buyers are willing to pay. It is more difficult to complete a transaction. If the gap is "narrow" there is a small difference between the price sellers are asking and the price buyers are willing to pay. It is easier to complete a transaction. 3. Resilience The resilience of a market refers to the speed at which prices return to previous levels following a large transaction - Kaya niya bumalik sa market price before the fluctuation How is Funding Liquidity Risk Measured? 1. Current Ratio This is a measure of a company's ability to pay its current liabilities using its current assets. It is calculated by dividing current assets by current liabilities. Current asset / current liabilities 2. Quick ratio The quick ratio, sometimes called the acid-test ratio, is identical to the current ratio, except the ratio excludes inventory, Inventory is removed because it is the most difficult to convert to cash when compared to the other current assets like cash, short-term investments, and accounts receivable In other words, inventory is not as liquid as the other current assets. A ratio value of greater than one is typically considered good from a liquidity standpoint, but this is industry dependent. Current asset - inventory/ current liabilities It is calculated by dividing the sum of cash, marketable securities, and accounts receivable by current liabilities. Cash + marketable securities + A/R / Current liabilities 3. Operating cash flow ratio The operating cash flow ratio measures how well current Liabilities are covered by the cash flow generated from a company's operations. The operating cash flow ratio is a measure of short-term Liquidity by calculating the number of times a company can pay down its current debts with cash generated in the same period. The ratio is calculated by dividing the operating cash flow by the current liabilities. A higher number is better since it means a company can cover its current babilities more times. An increasing operating cash flow ratio is a sign of financial health, while those companies with declining ratios may have liquidity issues in the short-term Operating cash flow / current liabilities Liquidity Risk Management Liquidity risk is an important consideration for most companies and Investors. While it is difficult to avoid altogether, there are ways it can be managed The first step in liquidity risk management is identifying which investments have high liquidity risk and which investments have low liquidity risk Liquidity Risk Management Which Investments Have the Highest Liquidity Risk? Investments that have the highest liquidity risk are more difficult to sell without taking a loss. Examples of investments with high liquidity risk include: - Matagal mabenta Fixed assets (e.g. land, equipment, property) Real estate Certificates of deposit Art Vehicles Issuing long-term loans (e.g. mortgages) Infrequently traded stocks (mga stock na Hindi madalas na mabenta) Investments that have the lowest Liquidity risk are highly liquid and therefore easier to sell without taking a loss. Examples of investments with low liquidity risk Include: - Mabilis mabenta Bonds Treasury bills Cash and cash equivalents Frequently-traded stocks (mutual funds) Mutual funds Money market funds INTEREST RATE RISK Interest rate risk is the potential for investment losses that result from a change in interest rates. If interest rates rise, for instance, the value of a bond or other fixed-income investment will decline. The change in a bond's price given a change in interest rates is known as its duration. Bonds rate and interest risk has a inverse relationship Interest rate risk can be reduced by holding bonds of different durations, and investors may also allay interest rate risk by hedging fixed-income Investments with interest rate swaps, options, or other interest rate derivatives. Bonds and interest rate have inverse relationship Duration - measure the sensitivity of a bond of interest rate changes (mas madaming naencounter si bond) TYPES INTEREST RATE RISK 1. Price risk The risk of change in the price of an investment bond or certificate is known as its price risk. This leads to unforeseen loss or gains while selling security in the future. Anything had to with the losses and gain The most common type of interest rate type of risk Also known as”MARKET RISK” 2. Reinvestment risk The risk of change in their interest rate might lead to the selling of the securities. In turn, this can lead to a loss of opportunity to re-invest in the current interest rate. Known as reinvestment risk, these types of interest rate risk can be further divided into 2 categories; Pwedeng magkaroon ng instances (Ibebenta niya ba o Hindi niya ibebenta) 1. Duration risk-risk due to the probability of unwillingness to extend an investment beyond its maturity period. 2. Basis risk of being subjected to a negative downturn in the market. Basis risk Mismatch between interest rate of hedged instrument Factors of Interest Rate Risk There are typically five types of interest rate risk on bonds and debt Instruments as follows: 1) Bond prices and their yields are inversely related. Thus, if a interest rate Increases the bond price falls or drops to a discount, and if the interest rate drops the bond prices rises or is considered at a premium. The fluctuations in the market is an interest rate risk that must be accounted for accordingly when investing. 2) The longer the maturity the more sensitive a bond or debt instrument is to interest rate changes. As a bond comes closer to its maturity the price fluctuates less and less from changes in the market. This means that a shorter term security has less interest rate risk. Mas matagal ang maturity ng bond mas malaki Ang interest rate 3) An increase in interest rates will yield a much larger change in a bond than a decrease of the same amount. This means that a bond has the ability to lose its overall value in price than it does in gaining or selling at a premium. Mas maganda na ibenta nalang kesa hintayin mo pa mag mature 4) Prices of low coupon bonds are much more sensitive to marset yield changes than the prices of higher coupon bonds. Related to the 1st factor (the inversely relationship) 5) A bond or debt instrument's price is much more sensitive if that particular bond has a lower yield to maturity. Thus, the higher the yield to maturity the less sensitive the bond price. Kapag long maturity Ang bond less sensitive Ang bond Note: None of these factors matter if a person plans on holding a bond or debt instrument until its maturity. if a person holds a band until its maturity the fact that Interest rates fluctuate is irrelevant because all bonds pay coupons and finally the face value at maturity. This means that this person will automatically make the desired return and therefore need not worry about Interest rate risk measures. How to Manage Interest Rate Risks? (APPLICABLE LANG KAPAG MAGBEBENTA NG BONDS) It is important to learn how to manage interest rate risk since it can potentially make an institution dysfunctional and ultimately bankrupt. 1. Diversification Among the different options that can be employed by an institution to manage the interest rate risk associated with them, one of the most effective options is to diversify their financial investments. For investors who invest in both equity and fixed investment options, this is the best method to manage the risks associated with interest rates. applied diversification para ma manage Ang mga investment (dapat Merong equity) 2. Safer investments The safest option for investors who are trying to reduce the risks associated with interest rates is to invest in bonds that have short maturity tenure. Securities with short maturity tenure are less susceptible to the fluctuations in interest rate. This method for interest rate management reduces the chance of being subjected to interest rate fluctuations since they have low maturity tenure. investment sa bonds na Meron short tenure or sa short maturity 3. Hedging Hedging is an option, which can be used successfully to reduce the risks related to interest rates. Generally referring to the purchase of various types of derivatives which are available, there are many ways of hedging. para reduce Ang potential losses 4. Selling long-term bonds. A common method which is often used is that of selling the long-term bonds. This effectively clears up the investment funds for re-investment in bonds with higher returns, thus allowing investors to manage the interest rate risk better. It is advisable to re-invest in securities which have shorter maturity tenure since these carry lesser risks related to interest rates. pwede ibenta o pwedeng reinvestment 5. Purchasing floating-rate bonds Floating rate bonds, as suggested by its name, have a rate of Interest, which is directly related to market fluctuations. It is advisable to invest in these securities since being related to the market fluctuations, the return on these investments go up and down too. bonds na Merong mga interest (sumasabay sa pagtaas at pagbaba ng price) possibly na pwede mababa o mataas Ang gain o losses CONCLUSION Interest rate risk is the potential that a change in overall interest rates will reduce the value of a bond or other fixed-rate investment: As interest rates rise bond prices fall, and vice versa. This means that the market price of existing bonds drops to offset the more attractive rates of new bond issues. Interest rate risk is measured by a fixed income security's duration, with longer-term bonds having a greater price sensitivity to rate changes, Interest rate risk can be reduced through diversification of bond maturities or hedged using interest rate derivatives. MARKET RISK (Hindi pwede iapply Ang diversification) Market risk is the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets in which he or she is involved. Market risk, also called systematic risk," cannot be eliminated through diversification because it affects the whole market, it is difficult to hedge as diversification will not help. Sources of market risk Include recessions -(decline in a economy)happening in a long period of time (more in external) Example : employment rate, inflation political turmoil-pagbabago ng jurisdiction ng Bansa (disturbance and uncertainty) changes in interest rates Systematic, or market risk tends to influence the entire market at the same time Main Types of Market Risk 1. Interest rate risk covers the volatility that may accompany interest rate fluctuations due to fundamental factors, such as central bank announcements related to changes in monetary policy. This risk is most relevant to investments in fixed-income securities, such as bonds. considered also market risk Affected Ang mga investment and bonds 2. Equity risk is the risk involved in the changing prices of stock Investment, anything that had to do with stocks 3. Currency risk, or exchange-rate risk, arises from the change in the price of one currency in relation to another. Investors or firms holding assets in another country are subject to currency risk. massive changes in the foreign currency to one another (Example: Dollars to peso) 4.Commodity risk covers the changing prices of commodities such as crude oil and corn. Volatility and Hedging Market Risk Market risk exists because of price changes. The standard deviation of changes in the prices of stocks, currencies or commodities is referred to as price volatility. Volatility is rated in annualized terms and may be expressed as an absolute number, such as $10, or a percentage of the initial value, such as 10%. Investors can utilize hedging strategies to protect against volatility and market risk. Targeting specific securities, investors can buy put options to protect against a downside move, and investors who want to hedge a large portfolio of stocks can utilize index options. Hedging strategies 1. Arbitrage It involves buying a product and selling it immediately in another market for a higher price; thus, making small but steady profits. The strategy is most commonly used in the stock market. 2. Average down The average down strategy involves buying more units of a particular product even though the cost or selling price of the product. has declined. Stock investors often use this strategy of hedging their investments. If the price of a stock they've previously purchased declines significantly, they buy more shares at the lower price. Then, if the price rises to point between their two buy prices, the profits from the second buy may offset losses in the first. 3. Staying in cash This strategy is as simple as it sounds. The investor keeps part of his money in cash, hedging against potential losses in his investments. Measuring Market Risk To measure market risk, investors and analysts use the value-at-risk (VaR) method. VaR modeling is a statistical risk management method that quantifies a stock or portfolio's potential loss as well as the probability of that potential loss occurring. The beta coefficient enables an investor to measure how volatile the nature or market risk of a portfolio or security is, in comparison to the rest of the market. It also uses the capital asset pricing model (CAPM) to calculate the anticipated return of an asset