Moderately Conservative Risk-tolerance Investment Policy - Assignment Example

? International Financial Market al Affiliation International Financial Market Asset allocation through moderately conservative risk-tolerance investment policy is created with the following principals: the goal of investment is to seek reasonable levels of capital protection while retaining the potential for some capital growth, security of capital take precedence over the potential wealth accumulation, the is to provide moderate returns with acceptance of moderate risk, acceptance of possibility of occasional losses but expectation of growth over the medium-term.( Cambell & Luis, 2002). As illustrated the primary goal in the moderately conservative risk-tolerance investment portfolio is capital protection. Based on this portfolio, long term strategic allocation will be 55 percent fixed income securities, 5 percent cash and equivalents and 40 percent equities. Using the above percentages on $100 Million portfolio we find that: The investment seeks current income with a secondary focus on capital appreciation. The fund invests in equity securities, bonds and money markets instruments. The target asset allocation of approximately 5% cash, 40% equities and 55% fixed income is enhanced. The actual asset class allocation can deviate from time to time from these targets as markets conditions warrants. The implementation of asset may involve the extensive use of equity and fixed-income exchange-traded funds. The investment policy based on moderate conservative allocation can be summarized in the table format below: Type of investment Percentage asset allocation Value Fixed-income 55 55 Cash and equivalents 5 5 Stocks 40 40 Total %100 $100 The multinational corporation can raise money for long term investment through primary capital markets. The decision can be made either to invest through bonds or shares. To avoid increasing its debt, expertise help is required. Shares offer the potential for higher returns and capital gains if the company is successfully progressing. (Davis, 1995). On the other hand if the corporation is doing poorly then bonds are safer as they are not susceptible to fall in price and in the event of bankruptcy bond owners are paid before shareholders. Raising finance from primary markets involves the process of face-to-face meetings. In the event that shares or bonds are chosen, the corporation will enlist the services of an investment bank to meditate between themselves and the bank and the market. Sound meeting should exist between the corporation management team and the investment bank. The investment bank then acts as an underwriter, and will organize for a network of brokers to sell the bonds or shares to investors. Most capital markets transactions occur on secondary markets. On primary markets, each security can be sold only once and the process to create batches of new shares or bonds is lengthy due to legal requirements. On the secondary markets there are no limits on the number of times a security can be traded and the process is usually very fast. With rise of strategies such as high-frequency trading, a single security could in theory be traded thousands of times within a single hour. Transactions on the secondary market don't directly help raise finance, but they will make it easier for corporation to raise finance on the primary market, in case the corporation wants to get its money back then they will re-sell their securities. Sometimes however secondary capital market transactions can have a negative effect on the primary borrowers - for example, if a large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity. Due to the nature of the corporation it would be prudent to buy shares or bonds with the highest grade or safest type of shares and bonds. The corporation can either be involved in two types of secondary markets: auction market or dealer market. These categories are more specialized. In the auction market the corporation will want to trade securities assemble in one area and announce the price at which they are willing to buy or sell. What is commonly known as bid and ask prices. The dealer market on the other hand does not require parties to converge in a central location. Rather, participants in the market are joined through electronic networks (from low-tech telephones or fax machines to complicated order-matching systems). The dealers hold an inventory of the security in which they "make a market". The dealers then can stand ready to buy or sell with market partakers. These dealers earn profits through the spread between the prices at which they buy and sell securities. Examples of dealer market are the NASDAQ, New York Stock Exchange and UK stock exchange. In which the dealers, who are known as market makers, provide firm bid and ask prices at which they are willing to buy and sell a security. The theory is that competition between dealers will provide the best possible price for investors. Dealer markets are also referred to as over-the-counter market. The term originally meant a relatively unorganized system where trading did not occur at a physical place, as we described above, but rather through dealer networks the multinational corporation can also trade in third and fourth markets. When the shares have accumulated to significant volumes then the corporation in conjunction with other investors can be involved in trading in third and fourth markets. These markets deal with transactions between broker-dealers and large institutions through over-the-counter electronic networks. The third market comprises OTC transactions between broker-dealers and large institutions such as Multinational Corporation. The fourth market is made up of transactions that take place between large institutions. The main reason these third- and fourth-market transactions take place is to avoid placing these orders through the main exchange, which could greatly affect the price of the security. Because access to the third and fourth markets is limited, their activities have less impact on the average investor. If the corporation decides to trade on bond securities then determination of the safety of the bond will be of prime importance. Each bond has an expiry date or maturity date at which time the bond issuer must return the principal to the investor. Taking time to study the market will help to answer complex questions concerning the trade. Also firms that are dedicated to determining the safety of the bonds sharing the information with brokers and investors can be contacted. As a rule of thumb, bonds that mature in less than five years are called short bonds. Those that mature in five to 12 years are called intermediate bonds. Long bonds have maturities of 12 years or more. By analyzing and understanding and comparing the factors such as credit rating and maturities the management team is capable of navigating through complex world fixed-income investing and determines bonds best for the chosen portfolio. With a level playing field for global investors the corporation can reap from the increasing benefits of international diversification. The investment by local investors within their economy is all sensitive to the business cycle and the political situations of that country. A portfolio invested in several countries can benefit from national economic cycles or events that are partly offsetting. The benefits of diversification also help to lower the risk of portfolios substantially without reducing the return expected. For example, although studies of international diversification differ as to the extent of these benefits, most conclude that exchanging a portfolio of U.S. stocks for an internationally diversified portfolio will reduce the standard deviation of the returns by at least 20 %.( Karim, 2002). The cost of involving in international markets has continually fallen, therefore more and more investors are choosing to take advantage of the benefits of international diversification. The barriers to international investments have been lowered and more emerging markets are steadily becoming accessible. Investment and financial industries are making it easier for investors to take advantage of international diversification. Finally, derivatives such as currency futures And swaps have made it easier to design and execute international asset allocation strategies that maximize the benefits of international diversification. Using swaps and futures, for example, an international fund manager can minimize the effects of withholding taxes by shifting the taxes to the party with the lowest tax rate. Convert income statement into US Dollars 1 US Dollar = 0.6138 pounds Q &R Manufacturing Income Statement 2012 [US DOLLARS] Sales 162,919.51 Cost of goods sold (COGS) 122,189.64 Gross profit 40,729.88 Selling expenses (2,437.93) Administrative expenses (I, 629.20) Marketing expenses (3,258.39) Profit 11.4 Major characteristics of the foreign exchange market Foreign exchange refers to the exchange of one currency for another or the conversion of one currency into another currency. Foreign exchange also refers to the global market where currencies are traded virtually around-the-clock. Foreign exchange transactions encompass everything from the conversion of currencies by a traveler at an airport kiosk to billion-dollar payments made by corporate giants and governments for goods and services purchased overseas. Increasing globalization has led to a massive increase in the number of foreign exchange transactions in recent decades. The global foreign exchange market is by far the largest financial market, with average daily volumes in the trillions of dollars. There are numerous characteristics of foreign exchange. The major ones are discussed below. 1. Barter exchange Just like in barter exchange, in the foreign exchange market there is usually a double coincidence of wants. For each person who desires to exchange his currency for another (say pounds or dollars), there is another person with the opposite currency and wants to exchange it for the other (say dollars for pounds), usually at a similar exchange rate. 2. In terms of role The financial exchange market does the role international clearing whereby it brings two parties together who desire to trade currencies at an agreed-upon exchange rate. Foreign exchange assists international trade and investment by enabling currency conversion. It supports direct speculation in the value of currencies and speculation based on the interest rate differential among different currencies. 3. Location Financial exchange market occurs between dealers and brokers worldwide at various financial centers. Bids for certain varied currencies are expressed via messages during business hours based on the different time zones of the participants. The exchange market has a wide geographical dispersion. 4. Profit-making The broker is obviously expecting to make a profit. This requires him to make fast decisions on the spot. Their life is exciting but also the pressure mounts leading to short careers. 5. Communication In foreign exchange market, the mode of communication has to be fast therefore the quickest available means of communication are used. Mostly it is usually telephones as it implies reduced costs as well 6. Low trading costs The foreign exchange market is characterized by relatively lower trading costs as one can start out with very little cash in comparison to other business ventures. This has presented opportunities for even individual investors to earn some money. 7. Transparency This enables the brokers too have access to all the market information they need to make appropriate decisions. Access to all the necessary information is a symbol of control on the trader’s part as he I free to make a full-informed decision. 8. Liquidity and Market size The brokers are at liberty to buy and sell whatever currencies they choose. This characteristic makes it easier for the traders to trade currencies and not affect the currency prices themselves. This means that the price of the currency does not change from the time an order is made to the time the execution of the order takes place. Trade between foreign exchange is usually very large, involving hundreds of dollars. It has huge trading volume representing the largest asset class in the world leading to high liquidity. 9. Market participants Participants involved in foreign exchange trade include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors. The foreign exchange is an over the counter market where dealers/brokers negotiate directly with each other. For this reason there is no central exchange house. The biggest geographical trading center is in UK in London. Foreign exchange market consists of two levels, which are interbank market and securities dealers. The levels of access that make up the foreign exchange market are determined by the size of the amount of money which they are trading. 10. Market trends Foreign market exchange is highly characterized by market trends as this is something traders rely on. The brokers carefully analyze the past and present foreign exchange data in order to be able to predict the future reports and make a decision based on that. Without following the market trends it would be hard for the traders to place a bid they are certain of. How do governments control the flow of currencies across national borders? Currency controls (capital control) are residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation's government can use to regulate flows from capital markets into and out of the country's capital account. These measures may be economy-wide, sector-specific (usually the financial sector), or industry specific (for example, “strategic” industries). They may apply to all flows, or may differentiate by type or duration of the flow (debt, equity, direct investment; short-term vs. medium- and long-term). Types of capital control include exchange controls that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country. There have been several shifts of opinion on whether capital controls are beneficial and in what circumstances they should be used. There are various ways in which the government can control the flow of currencies across national borders. Some of the ways are discussed below. 1) Limited bank withdrawals The government could limit the amount of money one can withdraw from the bank or even the ATM. A more aggressive approach is suspending the withdrawals. This hinders one from participating in the foreign exchange trade. 2) Legality The government can declare that the ownership or possession of precious metal illegal. This will restrict the trade in such goods with foreigners. 3) Conversion of savings The government can decide to convert your savings into new currency so it is hard for you to trade with foreigners. Otherwise, it could confiscate your savings. 4) Government bonds The government can force one to buy government bonds. This way he/she has no money left to be trading with foreigners. References Davis, E. (1995). Pension Funds: Retirement Income Security and Capital Markets— An International Perspective, Oxford University Press. Karim, A. (2002). “Structural Change and Yield Curve Anomalies in the Mexican Local Market,” Fixed-Income Research, Latin America. New York: Morgan Stanley. Cambell, Y, & Luis, M. (2002). Strategic Asset Allocation: Portfolio Choice for Long-Term Investors, Oxford University Press. Read More