BAFI1002 Financial Markets and Institutions

Executive Summary:

The report provides an insight about various parameters related to financial markets and assets classifications. The analysis deals with the evaluation of the Mr Tan Profile and also tries to justify various parameters which can support for future decision and analysis. The following report explains hedging ratio along with the four distinct asset classes that you are knowledgeable about and conduct a comprehensive analysis. It also explain the intermediate target for monetary policy in Australia and explain the implementation process. Thereby , alignment of these strategies with Mr. Tan's risk tolerance and overall investment plan. Thus the report closes by providing an appropriate conclusion and summary analysis.

Introduction:

Financial advisors must educate clients on market and economic systems. This will help them resolve investment concerns. This strategy builds customer trust and helps them to make informed decisions, enabling smart investments in unpredictable economic times. You must write a detailed Investment Strategy Report for Mr. Tan, your new client. It must match Mr. Tan's client profile, including his financial situation, risk tolerance, and investing goals. Mr. Tan is Singaporean and lives in Australia. He is 55 and Singaporean. He dreams of retiring in both countries while he seeks for an investing strategy. Mr. Tan has a five-million-dollar asset portfolio and takes prudent risks. His goal for the next decade is to progressively grow his portfolio by focusing on medium-term investments. Mr. Tan is a smart investor who prefers index funds and cost-effectiveness. He is also open to new suggestions that could boost his revenues. Mr. Tan may deposit $2 million into your account. The client looks to have overconfidence bias and home prejudice, according to your observations.

Section 1: Market conditions and Monetary Policy

Discuss current market conditions in Australia and globally that may impact investment decisions.

Economic expansion: Technology, consumer goods, and healthcare investment opportunities may improve if the economy is growing. In a recession or stagnation, investors may be more cautious and hesitant to invest.

Interest rates: Interest rate fluctuations can affect investing decisions, especially for fixed income assets like bonds. Rising interest rates make bonds and other fixed income productsore appealing to investors, but falling rates may push them to seek higher rewards (Bank, and Baum, 2024).

Currency fluctuations: Exchange rates can effect international assets, especially for Australian investors with foreign currency interests.
Market uncertainty from geopolitical events like political instability or conflicts can affect share prices and other assets.
Regulatory changes: Tax and environmental laws can affect investment decisions and create opportunities for industry investors (Bank, and Baum, 2024)

Analyse and plot the yield curve by using April 2024 monthly data of 1-month, 3-month Bank Accepted Bills, 3-year, 5-year, and 10-year commonwealth government bonds from the RBA website (https://www.rba.gov.au/statistics/tables/#interest-rates) and offer insights into the Australian economy's trajectory.

The yield curve is a key economic indicator of future interest rates and inflation. A steep yield curve predicts interest rate hikes and economic growth. In contrast, a flat or inverted yield curve predicts low interest rates and economic growth.

The Australian yield curve is flat, indicating moderate medium-term economic growth and inflation thus ensuring that it is mostly due to global economic uncertainty. However, the Reserve Bank of Australia's recent shift towards a more stimulative monetary policy may affect the yield curve(Khan, Mt, Abdulahi, Sadaf, Khan, Popp, and Olh, 2024)

Describe the intermediate target for monetary policy in Australia and explain the implementation process.

The intermediate goal for monetary policy in Australia is to maintain inflation at an average level of between three and four percent over the course of time Australia employs the cash rate as its policy instrument in order to accomplish the objective further the implementation process it is responsible for determining the target for the cash rate. This rate is the rate at which banks can borrow and lend overnight monies to one another. Through the reduction of the cash rate, the Reserve Bank of Australia intends to exert an influence on the cost and availability of credit within the economy, which in turn influences decisions regarding spending and investment (Mingminga, and Yu, 2024). Maintaining the intermediate inflation objective requires the Reserve Bank of Australia to frequently examine its policy stance and make adjustments to its cash rate target. The base choices on the cash rate on a variety of economic factors, such as the amount of GDP growth, inflation, and employment data (Mingminga, and Yu, 2024). The Reserve Bank of Australia makes adjustments to the cash rate in order to bring it into alignment with the current economic conditions along with the addition to this, it keeps track of the effects that the changes in the cash rate have, which gives it the opportunity to modify itself properly.

Offer examples of economic indicators that provide insights into future stages of the business cycle.

The business cycle, economic indicators are metrics that offer insights into the stages that will define the growth of the gross domestic product is one of these indicators. It will deal with the growth is a measurement of the whole output of goods and services in the economy along with the expansion phase of the cycle may be indicated by robust growth in the GDP, whilst the contractionary phase may be indicated by growth that is either moderate or negative. Data pertaining to employment that explains the levels can offer insights about the robustness of the labour market and the possibilities for consumer expenditure along with the increases in employment may be an indication of better economic growth, whilst decreases in employment may be an indication of a recessionary phase ( McKillop, French, Quinn, Sobiech and Wilson, 2020).

Data on inflation: The rate of change in the pricing of goods and services is what is measured by inflation. On the other hand, low inflation may indicate that a recessionary phase is about to begin, while high inflation may result in higher interest rates and a slowdown in economic growth.
Confidence of consumers and businesses: Measures of consumer and business confidence can provide insights into the sentiment of consumers and businesses, which can influence decisions on spending and investment (Neupane, Thapa, Marshall, Neupane, and Shrestha, 2024).

Explain how changes in key economic indicators influence cash rate decisions, referencing the recent RBA action.

The interest rate is affected by economic factors like the country's economic growth, price increases, and employment data. In times of low inflation and slow GDP growth, the Reserve Bank of Australia (RBA) might lower the cash rate to boost borrowing and spending. If inflation exceeds the Reserve Bank of Australia (RBA) objective range, the RBA may raise the cash rate to limit expenditure and prevent excessive growth(Neupane, Thapa, Marshall, Neupane, and Shrestha, 2024).
The Reserve Bank of Australia (RBA) has lowered the cash rate to 0.10%, expanding. It represents the global economic impact of the COVID-19 pandemic. The RBA aims to boost economic growth and employment in Australia, especially during uncertain times.

Section 2: Asset Classes Discussion

Select four distinct asset classes that you are knowledgeable about and conduct a comprehensive analysis.Based on Mr. Tan's profile and risk preference, market conditions, and available asset classes, recommend additional three additional suitable assets for his portfolio.

Equities, or stocks, are firm ownership shares.
Equities represent corporate ownership. Shareholders are entitled to corporate assets and profits. Common and preferred stocks exist. Voting is available to common shareholders.
Market, company-specific, and liquidity concerns. Corporations may face financial issues or market decreases due to stock price volatility.

Potential Returns: Stocks have historically provided long-term returns. Dividends and stock price rise generate profits. Returns rely on the firm and market conditions and are unpredictable.
Stock-listed Tesla, Inc. (TSLA). If you own Tesla shares, you might make or lose money with the firm.
Debt securities
Bonds: Investors give money to an issuer (usually a company or government) in exchange for interest payments and repayment of the initial investment at maturity. Interest rate, credit (default), and inflation risks are involved. Bonds may lose value if interest rates rise or the issuer defaults(Raheem, Akinkugbe, Yusuf, and Asl, 2023).
Potential Returns: Bond returns are more predictable than equity returns. Regular interest payments and maturity repayment of the initial investment are included. Although riskier, stocks offer better returns than other investments. The 10-year U.S. Treasury bond pays interest and repays the initial investment after 10 years and dealing with the Individual or corporate-owned land for investment or development.

Real estate investments include owning properties or investing in real estate-related assets like REITs. Real estate investments can provide rental revenue and boost property value.
Property market changes, inadequate management, and limited liquidity are concerns. Real estate values fluctuate and require ongoing maintenance. Renting out real estate can generate income and raise its value. Return rates vary by region and property type, but they are usually steady and disperse investment risk. Owning an apartment tower and collecting rent or investing in a REIT like Realty revenue with commercial assets might create revenue.
Commodities
Commodities are tangible goods like oil, gold, and agriculture. Investors can gain exposure through futures contracts, ETFs, or product ownership. Commodity prices fluctuate according to supply and demand, which poses hazards. Political, weather, and economic variables affect prices. Commodities can protect against inflation and diversify portfolios. Market dynamics, global events, and supply-demand mismatches affect market returns One could trade oil futures or invest in gold to hedge against inflation (Raheem, Akinkugbe, Yusuf, and Asl, 2023)

Explain to Mr. Tan regarding pros and cons of the right issue, assuming he owns 1000 Tesha shares and below scenario:

As part of the capital increase, we have determined the total number of new shares that are available for individuals to acquire. You have an initial ownership of one thousand Tesha shares, and the ratio of subscription rights is one to five. The implication of this is that you have the right to purchase one more share at a discounted price for every five shares that you already possess. Through the process of dividing your existing shares (1,000 shares) by the denominator of the rights issue factor (5), we were able to determine the number of new shares that you are able to purchase. As a result, you are able to purchase 200 additional shares.
According to the paper, this approach guarantees that the entitlement increases are utilised to their full and complete extent.
The cost of purchasing additional shares as well as the remaining Tesha shares should be defined as follows:
There is a price of $500 per share for the rights offering.
Using this price, you will be able to purchase 200 new shares.
The number of shares that you still possess is 800, which is equal to 1,000 minus 200.
Compute the price of the newly issued shares: Cost of new shares equals 200 shares multiplied by $500 per share, which equals $100,000
Do the following calculation to determine the value of your existing shares: The remaining value of current shares is equal to 800 shares multiplied by $800 per share, which equals $640,000.
possess one thousand Tesha shares in the outset, and the ratio of subscription rights is one to five. The implication of this is that you have the right to purchase one more share at a discounted price for every five shares that you already possess. Through the process of dividing your existing shares (1,000 shares) by the denominator of the rights issue factor (5), we were able to determine the number of new shares that you are able to purchase. As a result, you are able to purchase 200 additional shares. According to the paper, this approach guarantees that the entitlement increases are utilised to their full and complete extent it will cost to buy new shares, and then estimate how much worth the existing shares (Raheem, Akinkugbe, Yusuf, and Asl, 2023). At a subscription price of $500 per share, it would be possible to purchase 200 new shares at that price, which would result in a total purchase price of $100,000. While this is going on, the value of the remaining shares in the initial 1,000 share package is being determined, which comes out to $640,000 ($800 per share for 800 shares). Within this phase, we demonstrate the monetary repercussions that are associated with taking part in the capital increase. You have the option to raise your interest in Tesha while maintaining the value of your existing shares thanks to the investment of one hundred thousand dollars that you have acquired.After the rights issue, the total value of your Tesha shares is $740,000, which is the sum of the value of your new shares plus the value of the shares that are still outstanding. Consequently, this brings to light a new ownership structure and capital commitment that came about as a result of the rights issue. The possible advantages and disadvantages of this transformation are contingent on Tesha, Inc.'s future performance and share prices.

Section 3: Funds Under Management

Considering Mr. Tan's preference for cost-effective index funds and his pursuit of promising returns, provide an overview of funds in his portfolio and Investigate and evaluate the historical performance, risk, and return of these funds compared to benchmark indexes.

Suppose Mr. Tan's portfolio includes cost-efficient index funds like:
VTSAX is the ticker symbol for Vanguard Total Stock Market Index Fund.
Fidelity's 500 Index Fund (FXAIX) tracks the S&P 500 Index.
Financial products include the Schwab U.S. Broad Market ETF (SCHB).
Compare these funds' previous performance, risk, and returns to benchmark indexes.
These funds will be compared to the S&P 500.
VTSAX is the ticker symbol for Vanguard Total Stock Market Index Fund.
History: VTSAX has returned about 13% annually during the past decade.
Risk: 15% standard deviation.
Annual return: 13%.
The Fidelity 500 Index Fund
Over the past decade, FXAIX has returned 14% annually.
Risk: 14% standard deviation
Average annual return: 14%.
ETFs include the Schwab U.S. Broad Market ETF (SCHB).
Over the past decade, SCHB has returned 13% annually.
Risk: 15% standard deviation.
Annual return: 13%.
Considering Mr. Tan's penchant for low-cost index funds with high returns, consider:
ITOT tracks the whole U.S. stock market.
The Vanguard Growth Index Fund (VIGAX) invests in growth firms.
(Ziegler, Shneor, Wenzlaff, Wang, Kim, Paes, Suresh, Zhang, Mammadova, and Adams, 2021)

Explain fund measurement by calculating the coefficient of variation, Sharpe ratio and Jensens Index using the provided data and provide an interpretation of calculations.

Using hypothetical data for illustration:
Coefficient of Variation (CV):
oFor VTSAX: CV_VTSAX = (15 / 13) * 100% ? 115.38%
oFor FXAIX: CV_FXAIX = (14 / 14) * 100% = 100%
oFor SCHB: CV_SCHB = (15 / 13) * 100% ? 115.38%
Sharpe Ratio:
oFor VTSAX: Sharpe_VTSAX = (13 - 2) / 15 = 0.733
oFor FXAIX: Sharpe_FXAIX = (14 - 2) / 14 = 0.857
oFor SCHB: Sharpe_SCHB = (13 - 2) / 15 = 0.733
Jensen's Alpha:
oFor VTSAX, we need to calculate the beta (?) first. Assuming the market return (Rm) is 10%: ?_VTSAX = (13 - 2) / (10 - 2) ? 1.44 Jensen_VTSAX = 13 - (2 + 1.44 * (10 - 2)) ? 6.72%
oFor FXAIX: ?_FXAIX = (14 - 2) / (10 - 2) ? 1.56 Jensen_FXAIX = 14 - (2 + 1.56 * (10 - 2)) ? 7.04%
oFor SCHB: ?_SCHB = (13 - 2) / (10 - 2) ? 1.44 Jensen_SCHB = 13 - (2 + 1.44 * (10 - 2)) ? 6.72%
Interpretation:
A lower degree of risk is indicated by a coefficient of variation (CV) that is smaller (smaller values). Consequently, the amount of risk associated with FXAIX is the lowest among the three fund anda greater Sharpe ratio indicates a stronger risk-adjusted return, FXAIX also demonstrates the highest risk-adjusted return and is therefore the best investment.It is favourable When taking into account the amount of risk that the fund is exposed to, Jensen's Alpha indicates that the fund is already producing returns that are higher than what was anticipated. The fact that FXAIX and VTSAX both have positive Jensen's Alpha indicates that they are outperforming the market (Ziegler, Shneor, Wenzlaff, Wang, Kim, Paes, Suresh, Zhang, Mammadova, and Adams, 2021)

Section 4: Hedging Using Derivatives

Discuss the potential use of derivatives (e.g., options or futures) to hedge Mr. Tan's portfolio against adverse market movements.

Derivatives can hedge Mr. Tan's portfolio against market fluctuations given his profile and goals. Here are probable derivatives and their relevance to Mr. Tan can be Options: Mr. Tan can use options to mitigate downside risk and retain portfolio growth potential. He could buy index fund put options to hedge against market falls. Additionally, futures contracts can be used for hedging purposes (Bank, and Baum, 2024) Mr. Tan might hedge stock market drops with equity index futures as well as dealing with the factor which can lead to the can balance portfolio losses by shorting futures contracts.

Explain the benefits and risks associated with derivatives-based hedging strategies.

Advantages of Derivatives-Based Hedging leads to the factor which being the derivatives shield Mr. Tan's portfolio from market fluctuations, managing potential losses. Moreover , the derivatives offer flexibility in adjusting hedges to specific risks and timeframes, allowing Mr. Tan to customise his strategy for his investment horizon. Further, understanding the factor which being the doing a appropriate format of hedge his portfolio more efficiently by using derivatives, which need less upfront money than selling assets.

Risks of Derivatives-Based Hedging:

Derivatives trades may incur fees like option premiums or futures margin requirements, which can reduce returns if not managed properly. Thereby, dealing with the element of having a derivative transactions may involve counterparty default, however reputable counterparties can limit this risk (Bank, and Baum, 2024) . Thus, also ensuring and understanding derivative mechanics and associated dangers is crucial.

Assess the alignment of these strategies with Mr. Tan's risk tolerance and overall investment plan.

Mr. Tan's moderate risk tolerance and his goal of medium-term portfolio growth, hedging that is based on derivatives can protect Mr. Tan's assets against losses and give him the opportunity to generate gains. In spite of this, Mr. Tan's preference for index funds and his cost-conscious technique should be taken into consideration when employing strategies that use derivatives(Mingminga, and Yu, 2024).
Compared to the benefits of hedging, the cost-effectiveness and simplicity of the derivatives that are selected should not be more advantageous and dealing with the overconfidence bias and home bias, you should provide him with complete knowledge regarding the benefits and drawbacks of hedging solutions that are based on derivatives.

Conclusions:

A financial advisor to ensure that their clients have a comprehensive understanding of the foundations of economics as well as the mechanisms that govern the market and they are able to successfully manage the intricacy of investing, even when the market is confusing, as a result of the competence that they possess.

Purpose of ensuring that Mr. Tan's investments are in accordance with his specific profile, it is imperative that you create a detailed Investment Strategy Report which must be reported ought to take into account a number of different variables, such as his current financial situation, his level of risk tolerance, and his investing objectives. None the less the aim of generating an Investment Strategy Report for Mr. Tan, it is vital to have a full understanding of his profile, in addition to his investment goals and the current market conditions that are available.

In order to develop a comprehensive investment plan that is in accordance with Mr. Tan's objectives while simultaneously managing risks, it is possible to accomplish this by conducting a study of market dynamics, evaluating asset classes, evaluating fund performance, and taking into consideration hedging measures. Additionally, it is essential to educate Mr. Tan on the logic behind investment selections and to provide transparency throughout the process in order to foster trust and confidence in Mr. Tan's journey through the world of investing.

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