Thursday, 30 January 2014

Singapore Stock Exchange - Structured Investment Products (SIPs)

I have recently decided to get myself SIP certified and I registered for the online education at SGX seeing as to how I did not meet certain requirements in order for me to invest in SIPs. SIPs includes warrants and options, exchange traded funds and notes, futures, certificates and callable bear/bull contracts. I have copied and paste SGX's definition of SIPs and you can see it below.

One of the key reason why I decided to look into SIPs was due to the promise of leverage, and if I ever hoped to reach a certain financial goal by the time I graduate, I have to take on more calculated risks, especially in this uncertain market condition. I will tell you what I have learnt and at the end of this post, take the SIP quiz.

A derivative is a type of financial contract whose value is dependent upon or derived from other underlying assets. The underlying asset can be financial which includes both physicals like equities and currency or intangible like interest rates and equity index, metals, agricultural commodities, or energy like fuel oil. When a derivative contract is bought, you do not own the underlying asset, you are merely betting if the underlying asset will go up or down. There might be another person at the other end of the trade, be it a high net worth investor, an institutional investor or even just another guy hoping to make it rich. Yet, the game is simple. If you win, they lose, if they win, you lose. In short, THE WINNER TAKES IT ALL.

Uses of derivatives includes speculation, hedging, leverage, or even exposure to certain asset that cannot be traded.

Warrants & Options
These financial contracts are the right to buy or sell the underlying stock at a specific price (strike price or exercise price) by or on a specific date (expiry date). Call is the right to buy while Put is the right to sell the underlying asset. There are 2 styles of warrants and options, namely European and American style. European style only permits the exercise of the contract on expiration while American style contracts permits the exercise of the contract on any trading day on or before expiry date. Most of the structured warrants listed on the SGX are European style. The warrant/option is useless pass the expiry date so do take note when buying these contracts.

There is a conversion ratio relevant to the warrant only. It determines the number of warrants required to exercise into 1 unit of the underlying asset which most of the time tend to be equities. There are various factors that influenced the price of the financial contracts and they are underlying asset price, exercise price of warrant, time to expiry of warrant, dividend yield of underlying asset, volatility of the asset and prevailing interest rates, macroeconomic factors and the solvency of the asset. There are also a few risks associated with trading these financial instruments and they are foreign exchange risk, issuer risk, market risk, liquidity risk, and leverage risk.

Exchange Traded Funds (ETFs)
These funds are actually investment funds managed by professional managers. It provides exposure to different asset classes like equities, commodities, bonds and more. Their performance aim to replicate and follow the performance of a particular index in the long run. NAV/unit is equal to the total assets - total liabilities divided by number of outstanding ETF units. ETFs are split into 2 types, namely cash based and synthetic. Methods used to track the index for cash-based ETFs include direct replication and statistical or representative sampling, while methods used to track synthetic ETFs include synthetic replication. There are long and short ETFs and long ETFs are expected to perform in the same direction as the underlying index by the same percentage while short ETFs will perform inversely by the same percentage.

Advantage of buying ETFs includes low distribution expenses and price transparency. They cost almost the same to buy as equities since they are listed on SGX while unit trusts can take up to 3 to 5% of sales charges. ETFs experience market risk, tracking error, counterparty risk, liquidity risk and foreign exchange risk.

Exchange Traded Notes (ETNs)
The ETNs are debt securities usually issued by investment banks designed to track the performance of underlying assets such as equity index, commodity price and more. Returns of ETNs are tagged to the performance of the underlying assets. They do not provide coupons like bonds, do not pay interest and do not guarantee return of capital.

Futures are financial contracts that has the obligation (contrary to options/warrant that has the choice) to buy or sell the underlying assets at a set quantity, price, date. There are 2 different types of futures, namely financial (currencies, equities, equity indices etc) and commodity (crude oil, gold) futures. Trading in futures are subject to margin requirements. Futures are settled in 2 ways, physical delivery and cash settlement. The settlement method is laid out in the contract. Futures are traded on margin and require an initial cash outlay (initial margin) and is a fraction of the full value of the contract. With futures, leverage is present. Futures are marked to market on a daily basis. A margin call is issued when the initial margin is eroded by losses and the account falls below the minimum margin requirement (maintenance margin). The additional amount required to restore the account to the initial margin is called the variation margin.

Certificates are investment products issued by a third party financial institution (usually an investment bank) to enable profits to investors from movements in the price of the underlying assets. A discount certificate allows one to buy the underlying asset at a discounted price. However, because there is a discount, there is a limit to how much the investor can profit and he will only be compensated to a certain price level (cap strike).  

Callable Bull/Bear Contracts (CBBCs) 
CBBCs are financial products again issued by third party issuers. They follow the price performance of the underlying asset very closely. When the CBBC is called by the issuer, one will no longer be able to trade the CBBC on SGX. As I scan through the slides for this type of financial product, I feel that it is best not to venture into this area as it seems a bit too sketchy for my own personal investment. There are much more clearer financial instruments like warrents/options and futures to achieve the same goal of making a profit on the SGX.

Attached is my result slip. I took the quiz the first time and I passed. I took around one hour and thirty minutes to learn the lesson while typing out this post as well. I foresee many days of using leverage as a tool to invest. I need to gain my wealth faster and stronger, I wish to retire before 30, while having multiple business and I only have a few years to achieve that.

I will be more hardworking and stronger in my drive to succeed. I was sick last week and that has made me put off studying and learning. I also need to participate in a few competitions and hone my skills. I have not registered for the corporate courses as well, something that I say I will do. Time is running out, I need to be more active and driven.

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