> Credit risk is considered as an investor's risk of loss arising from a borrower who does not make payments as promised. Market risk, meantime, refers to the risk to an institution resulting from movements in market prices, particularly, changes in interest rates, foreign exchange rates, and equity and commodity prices.
The Monetary Authority of Singapore (MAS)'s guidelines point out that in credit risk management an institution should determine the level of credit risk that it can bear that should develop a risk management strategy which is consistent with its credit risk tolerance and business goals. In formulating this strategy, the institution should consider the following: the business cycle stage it is operating in; the nature of its business franchise and its relevant credit market segments; the portfolio mix that balances its willingness to bear concentration risk with sufficient diversification; and the business targets it has set for particular lending segments. Additionally, the Board of Directors might periodically review the credit risk strategy and any changes and concerns should be effectively communicate to all relevant staff.
In according to the continuation of the guidelines of MAS, in the strategy of market risk management an institution should develop a sound and well informed strategy to manage market risk. The strategy should first determine the level of market risk the institution is prepared to assume. Once its market risk tolerance is determined, the institution should develop a strategy that balances its business goals with its market risk appetite. In setting its market risk strategy, an institution should consider the following factors: economic and market conditions and their impact on market risk; whether the institution has the expertise to profit in specific markets and is able to identify, monitor and control the market risk in those markets; and the institution's portfolio mix and how it would be affected if more market risk was assumed. The institution's market risk strategy should be periodically reviewed and effectively communicated to the relevant staff. There should be a process to detect deviations from the approved market risk strategy and target markets. The Board of Directors and senior management should periodically review the institution's market risk strategy taking into consideration its financial performance and market developments; and set out the scope of activities of the business units assuming market risk.
For credit risk management, MAS instructs that an institution should adopt a risk management structure that is fit with its size and the nature of its activities. The organisational structure should facilitate effective management oversight and execution of credit risk management and control processes. A senior management committee should be formed to establish and oversee the credit risk management framework.
Generally, for aiming to provide financial institutions with guidance on sound credit and market risk management practices, the Monetary Authority of Singapore emphasises four key pillars of effective risk management that: the role of a financial institution's board of directors in its oversight of risk management policies and their implementation; the role of senior management in ensuring that sound policies, effective procedures and robust systems are in place; the presence of sound risk management processes and operating procedures that integrate prudent risk limits with appropriate risk measurement, monitoring and reporting; and the presence of competent personnel in the risk management, control and audit functions.
The guidelines that capture sound industry globally practices are not intended to be exhaustive or to prescribe a uniform set of risk management requirements for all financial institutions. Financial institutions should implement a risk management framework which is commensurate with the nature, size and complexity of their operations. Strong risk management culture at all levels of the organisation and clear oversight by board and senior management in implementing effective systems and processes are crucial factors in an effective risk management framework for any financial institution. By issuing these guidelines for financial institutions to draw from, MAS aims to strengthen risk management in the financial sector and encourages financial institutions to review and implement the sound practices recommended in the guidelines where appropriate.
Reference:
1/ Wikipedia Encyclopedia. Credit Risk. [online] (Last updated on 16th August 2010) Available at: <http://en.wikipedia.org/wiki/Credit_risk> [Accessed on 28 August 2010]
2/ Wikipedia Encyclopedia. Market Risk. [online] (Last updated on 30th June 2010) Available at: <http://en.wikipedia.org/wiki/Market_risk> [Accessed on 28 August 2010]
3/ Monetary Authority of Singapore (MAS). Guidelines on Risk Management Practices. [online] (Last updated on 23rd July 2008) Available at: <http://www.mas.gov.sg/legislation_guidelines/risk_mgt/Guidelines_on_Risk_Management_Practices.html> [Accessed on 28 August 2010]
4/ Asia Studies. Monetary Authority of Singapore Guidelines. [online] (Last updated on 05th March 2010) Available at: <http://www.asia-studies.com/MAS.html> [Accessed on 28 August 2010]
5/ Continuity Central. The Monetary Authority of Singapore issues guidelines on sound risk management practices. [online] (Last updated on 27th February 2006) Available at: <http://www.continuitycentral.com/news02389.htm> [Accessed on 28 August 2010]
QUESTION 2 (20 MARKS)
(a) Financial innovation, which is a feature of the past 25 years, has been greatly influenced by changes in regulation, technology and market volatility. Comment on this statement using valid examples. (10 marks)
(b) Using Singapore Financial Sector as an example, explain why the globalization of the financial services industry has created more problems for Singapore regulators. Support your answers with recent development in the financial markets. (10 marks)
> (a) Financial innovation, which is a feature of the past 25 years, has been greatly influenced by changes in regulation, technology and market volatility. Financial innovation has already transformed the financial services industry. Fourteen years ago, who expected the massive growth of e-banking and e-brokerage? Who envisioned the entry of new players such as retailers and telecommunications providers into financial services arena thanks to their ability to harness the power of innovative technology? Who predicted that technology would enable outsourcing and offshore contracting of core financial processes in lowcost countries such as India? The business environment continues to change today, and the financial services sector needs to confront many issues to remain competitive. In particular, technology and innovation are board level issues; they create opportunities and pose threats.
Simultaneously, the business environment across the globe has been witnessing an unprecedented turmoil over the last couple of years. Many financial institutions, corporations and global economies which have been foundations of the global markets and financial structure have collapsed or are surviving on life support systems. The process of change is going on in every spare of financial system - financial institutions and their regulations, financial markets, corporate governance, legislations, accounting and auditing, naming a few.
For example of the financial innovations, some types of financial instrument became prominent after macroeconomic conditions forced investors to be more aware of the need to hedge certain types of risk as: the development of interest rate swaps in the early 1980s after interest rates skyrocketed or the development of credit default swaps in the early 2000s after the recession beginning in 2001 led to the highest corporate-bond default rate in 2002 since the Great Depression. At this juncture we need to be more innovative and creative - but our innovations should lead us to progress rather than destructions.
Reference:
1/ Wikipedia Encyclopedia. Financial Innovation. [online] (Last updated on 30th July 2010) Available at: <http://en.wikipedia.org/wiki/Financial_innovation> [Accessed on 28 August 2010]
2/ World Economic Forum. Technology and Innovation in Financial Services: Scenarios to 2020. [online] (Last updated on 15th April 2009) Available at: <http://www.weforum.org/en/initiatives/Scenarios/TechnologyandInnovationinFinancialServicesScenarios/index.htm> [Accessed on 28 August 2010]
> (b) By the late 1980s with the globalization of the financial services industry, Singapore had become a robust city state, playing host to some of the world's biggest organizations and multinational corporations. Its manufacturing and commerce sectors were reaching their peaks and along with it, financial services grew to become a substantial portion of the country's GDP. By then, it was evident that the financial sector was no longer merely a supporting arm but a key industry of the nation, contributing significantly to the economy and having a life of its own. Yet, as compared to the major economic powerhouses such as U.S, U.K and Japan, Singapore stood miserably in terms of sophistication in technology and human talent. However, there was a huge risk involved in developing Singapore's financial sector as it meant allocating resources away from other sectors into one whose future was no uncertain.
The aim to develop Singapore as a financial sector was executed nevertheless, but under the heavy handed and well-organized direction of the Monetary Authority of Singapore (MAS). Hongkong was also developing its financial sector at the same time but under a laissez fair system, therefore leaving no exemplary economy for Singapore to learn. Throughout the years, Singapore's banking and financial sector grew from providing basic and standard services, to sophisticated, technology-driven, innovative offerings. In consequence, the financial services sector developed simultaneously with the growth of the Asian Currency Unit, the Asian Dollar Bond market and the Singapore Dollar Corporate Bond market.
Like most ASEAN economies, Singapore is too small to affect world-wide trends. Though a small player in the global network, it is an important financial center in the Asian region. Common effects of globalization (comprising increased advanced technology standards, merging legal frameworks, global security, multilateral competition for resources and the conflicting needs of offering customized services and products of international standards) remain the critical issues to be resolved by Singapore regulators to ensure the continued relevance of the tiny market to the world. Still, while Singapore's financial institutions weathered the crisis well, a significant number of Singaporeans suffered losses from having bought structured products related to Lehman. And many who had invested much of their life savings in the mini-bonds found that they were worthless. At end-May 2009, more than 3,600 investors have been offered settlement worth a total of S$105 million on a no-admission-of-liability-basis. That is about two-thirds of all cases that had been decided, including 25% who received full compensation.
More details are expected soon when Singapore regulators and the MAS release the findings of theirs completed investigations. Broadly speaking though, Mr Goh, who is also Chairman of MAS, said financial institutions will need changes to both their business models as well as mindsets to win back the trust and confidence of consumers and must not waste the current crisis. Whether as Singapore financial institutions, regulators or as consumers, this downturn has not only taught new lessons, but also presented opportunities for the nimble and prepared.
The sector needed to build on its talent pool and tap on the opportunities arising from the massive infrastructure needs and growing wealth in Asia. The speedy urbanization will bring about more infrastructure plans, which can spur the growth of project financing in Asia. Demographic tendencies in Asia are expected to drive the demand for greater wealth planning, including asset management, as well as life and healthcare insurance products. Those are problems that Singapore regulators must solve. Meantime, as investors shift towards demanding less complex and more transparent investment instruments, authorities are working to improve access to Singapore Government Securities (SGS), generally considered a liquid and safe investment alternative.
Reference:
1/ Wikipedia Encyclopedia. Financial Market. [online] (Last updated on 18th August 2010) Available at: <http://en.wikipedia.org/wiki/Financial_market> [Accessed on 28 August 2010]
2/ Finance Maps of World. Singapore Financial Market. [online] (Last updated on 02nd January 2009) Available at: <http://finance.mapsofworld.com/finance/market/singapore.html> [Accessed on 28 August 2010]
3/ Channel News Asia. Prospects for Singapore's financial sector brighten, says SM Goh. [online] (Last updated on 26th September 2009) Available at: <http://www.channelnewsasia.com/stories/singaporebusinessnews/view/438751/1/.html> [Accessed on 28 August 2010]
QUESTION 3 (20 MARKS)
China Yong Ann Limited, a property development company listed in the Singapore Stock Exchange, has an annual turnover of S$80 million and a pre-tax profit of S$15,400,000. Lately, the elder son, Mr Cui Yong, has been appointed as CEO to replace his aging father. Since taking rein of the company, the new CEO has been studying ways on how to increase value to its share holders.
You are the newly engaged Financial Consultant of this company, with many years of experience assisting public listed companies to enhance their market values. You know that a company shareholder value is driven by the four key elements as below: (i) Amount of Capital Invested; (ii) Required Rate of Return; (iii) Actual Rate of Return on Capital; (iv) Planning Horizon
Required:
Write a brief summary report to the company's Board of Directors to explain how a Business can creates value based on the four elements above. You may need to use examples in your write-up to illustrate your understanding on the above concepts. (20 marks)
> Summary Report to The Company's Board of Directors:
As we all know, shareholder value is driven by the following 4 elements: the amount of capital invested; the required rate of return on capital invested; the actual rate of return on capital invested; the length of time over which the performance spread will persist to create value. And, crucially, the actual return must be more than the required return for value to be created. That is, there must be a positive performance spread.
The performance spread is the percentage spread of the actual return above or below the required rate of return, given the finance provider's opportunity cost of capital. To measure annual value created or projected value yet to be created, multiply the quantity of capital invested by the performance spread.
Annual value creation = Investment x (actual return - required return) = I (r - k)
This point in the future in which the required and the actual rates of return become the same is the "planning horizon".
Corporate value = Present value of cash flows within planning horizon + Present value of cash flows after planning horizon
After the planning horizon even if investment levels are increased significantly corporate value will remain constant. This is because the discounted cash inflows (to time zero) associated with that investment exactly equal the discounted cash outflows (to time zero). In other words, after the planning horizon it is not possible to make returns greater than those required by investors.
Good growth and bad growth: Good growth occurs when a business unit or an entire corporation obtains a positive performance spread on new investment capital. Bad growth occurs when investment is made in strategies that produce negative performance spreads.
There are five key actions firms can take in order to increase shareholder value: increase the return on existing capital; raise investment in positive spread units; divest assets from negative spread units to release capital; extend the planning horizon; and, lower the required rate of return.
Reference:
1/ Finance Matters. Creating Value. [online] (Last updated on 13th January 2010) Available at: <http://baitshepi-tebogo.com/page2.htm> [Accessed on 28 August 2010]
2/ Scribd. The Handbook of Corporate Finance. [online] (Last updated on 12th August 2010) Available at: <http://www.scribd.com/doc/35762808/The-Handbook-of-Corporate-Finance> [Accessed on 28 August 2010]
3/ Pegasus Communications Inc. Value Creation and Business Success. [online] (Last updated on 15th July 1998) Available at: <http://www.pegasuscom.com/levpoints/valuecreate.html> [Accessed on 28 August 2010]
QUESTION 4 (20 MARKS)
Taking the Singapore financial market for example, how do interest rates affect the values of Assets? Support your answer with illustrations using at least 2 examples.
> Over 20 years, Proactive Structural Dynamic Simulation of Singapore, Central Bank Optimal Monetary, Economic, Fiscal Policy Impact on Inflation, unemployment, GDP, Assets (Stocks, Bond, Housing, Commodity), Prices Bubbles Identification, inflation, deflation, burst, recovery, early warning, performance guidance and control in achieving optimal growth and price stability by Proactive Structural Dynamic Optimal monetary, economic, fiscal, trade policy, capital markets integration. Singapore economy will facing slowdown to 5.0% GDP in the second half this year, housing marketing facing overheating due to China 568 billion economic stimulus, 8 trillion RMB increase in loan for stimulus program, U.S 8 trillion bailout, stimulus for financial crisis, recession recovery Singapore's 20 billion stimulus, DBS housing easy credit and rate cuts resulted excessive liquidity driving global stock market prices bubble up 50-100% led to China housing prices up 70% exceeding 2007 peak, stock prices bubble with PE ratio approaching 2007 peak, led to China Peoples Banks removing 2 trillion excessive liquidity in stocks, housing forced, rises second hand mortgage down payment to 60%, most banks stops making housing loan in the second half of 2009, which leads to new loan increase in August plunged from 1.6 trillion in June to 4000 billion into the real economy.
Global slowdown in the second half facing slow down to GDP of 5%, U.S 1Q GDP growth at 3.2%, April PMI at 60, and rebound in housing and retail sales 2010 all due to housing stimulus credit soon to expire in April, and tax rebate resulted consumer spending rebound at 6% will peaking out after May. Greece, Euro area debt crisis (despite one trillion bailout to support Euro and PIGS debt crisis will not be able to solve the worst economic, financial crisis in Euro history since World War I, it will drag GDP growth to 1% and recession, dollar appreciation from 1.5 to 1.20%. U.S FED to remove more than 1 trillion excessive liquidity from capital market already cut m2 money supply growth from year ago 10% peak to March 1.3% Euro will further slowdown U.S export growth in the second half, facing credit tightening, rate hike as summer inflation heat up, China credit tightening slow GDP to 8% by year end, whilst India, Australia, Korea interest rate hikes will slowdown GDP growth, leading to U.S export decline related while any further exit strategy, credit tightening, inflationary control, rate hikes will lead to economic growth double dip to below 2.5% by year end.
U.S FED aggressive rate cuts drag dollar to 1.53-1.65 Euro, 95-108 Yen, economic stimulus boost consumer spending on gasoline and jet fuel summer, demand, driving gasoline, heating oil to 415, oil price to 121-145, commodity price double, will peak out as U.S dollar rebound follow FED ending rate cuts cycle, cannot stop sub-prime crisis spreading, regional housing price slump 30-50% and credit crisis, crunch crisis continue through 2009 drag economy into 2009 double dip inflationary recession resulted trillion housing and stock market loss and U.S, global stock indices bear market 50%, DowJones tests 7000-8000, Nasdaq tests 1250-1500 and high fliers (GOOG, PTR, AAPL), IT, retail stocks facing correction, with banking, finance, housing share price plunge 70-90%, dollar making to new low 90 Yen. China overheated housing, stock market wealth gain resulted inflation over 8.7% will lead to China Peoples Bank credit tightening to remove excessive liquidity, banking housing, stock markets follow U.S housing price slump, recession, bear market correction, with Shanghai A testing 1800 through early 2009 until economy softlanding.
Singapore is suffered by housing, equities, commodities asset rice bubbles and spread from U.S credit, financial, crisis, recession and China slowdown 2008. Private investment index: suffered by U.S, global credit, financial, crisis, recession, export slowdown export, Strait Times stock index, this index soared 50 % money supply growth slowdown to 10% leading to rebound in properties prices still up 9% in October 2008. Private consumption index privae consumption down 3% manufacturing production index down 11% hurt by U.S, Japan, Euro recession. Export down 5% . Trade Surplus: Up to 1.5 billion due to oil prices declining import and export boost.
Singapore Dollar Currency steady at 1.5 due to steady trade surplus of and US dollar weakness will be traded between 1.5-1.6. Strait Time Index will follow Nasdaq retreat and will be traded between 1450-1700. Agricultural, food prices will down 20% due to falling oil commodities prices will be stabilize. Inflation still under control up 6.5%, property price still 9%, declining interest rate is 0.87%. Singapore strait times index will be traded between 1550-1900 and will be dragged down by Nasdaq correction and banking, finance stocks are over priced will follow U.S banking finance stocks 10% correction due to soaring bad loan in stock market slump in the weeks ahead.
Dynamic tracking simulation the root causes, onset, recovery of ASEAN currency crisis, Asian financial crisis and U.S new economy bubble burst, Euro economic slowdown impact on Singapore macro GNP, inflation, export, interest rates, currency, stocks, commodity, electronics, products, properties prices impact on consumer and business spending, to predict, forecast overpriced asset prices resulted consumers spending imbalance and business profit slump due to central banks raising interest rates to cool off the economy, leading to bubble burst and abrupt change in consumer and business confidence caused stock prices plunges with average error below 1.5 %, correlation constant above 0.95.
