ASSIGNMENT TOPIC: Market interest rates and its implications on investment decisions PREPARED BY: ABDUL QADIR Introduction: The topic of my assignment is the market interest rates and its implication on investment decisions. Every person needs money to live a better life. Now there are different modes of gaining money like the person can start a business or to invest it. Everyone today appreciates the need to save whether for a house, for Children’s education, a wedding, or for use after retirement. All these goals can be realized through excellent financial planning. An intelligent plan Entails investing your money in an appropriate combination of assets with potential to generate the income needed to achieve your goals. If we invest wisely, we can maximize the return on our investments. There are many investment avenues available, but a wise investor does not invest on impulse, a hot tip or follow the herd. An investor should discriminate between information, casting away irrelevant and illogical pieces of information, and checking for opportunities and facts before making an intelligent choice of investments. Now when we talk about investment, there are also many types of investments. Now the investment in stock exchage or the investment in any private business. One thing is to be remembered that where we invest the affect of or we can say that the risk of interest rate will be there. Now greater the risk the higher will be the return. But this is doesnot mean that to get a high return we will have to take risk, but infact financial planning will be needed. Because there are many ways through which we can minimize the risk one is the diversification. The investment in stock exchange The aim of investing in stocks and shares is to buy at low and sell at high. Knowing when is however, the problem. Many investors attempt to time the market: they try to figure out when the market is going up and buy before it does and then anticipate when it is going to crash and sell before that. Usually you try to buy when the upswing has begun and sell as the downswing starts. However, such accuracy is extremely difficult to achieve. Understanding investment The term "investment" is used differently in economics and in finance. Economists refer to a real investment (such as a machine or a house), while financial economists refer to a financial asset, such as money that is put into a bank or the market, which may then be used to buy a real asset. In finance, investment is equal to cost of capital, like buying securities or other monetary or paper (financial) assets in the money market or capital markets, or in fairly liquid real assets, such as gold, real estate or collectibles. Valuation is the method for assessing whether a potential investment is worth its price. Return on investment will follow the risk return spectrum. Types of financial investments include shares. Other equity investment and bonds These financial assets are then expected to provide income or positive future cash flows, and may increase or decrease in value giving the investor capital gains or losses. Investments are usually made through intermediaries. Such as bank, mutual funds, pension funds, insurance companies, though their legal and procedural detail differ, an intermediary usually made investment using money from many individuals, each of whome receive a claim over the intermediary. Interest Interest is the price paid for the use of savings over a given period of time. Interest is a fee paid on borrowed capital. Assets lent include money, consumer goods through hire purchase. The fee is compensation to the lender for foregoing other useful investment that could have been made with the loaned money. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of the use of the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit. Interest is therefore the price of credit, not the price of money as it is commonly - and mistakenly - believed to be. The percentage of the principal that is paid as a fee (the interest), over a certain period of time, is called the interest rate. Market interest rates Who sets the interest rates? There are markets for investments which include the money market, bond market, as well as retail financial institutions like banks, which set interest rates. Each specific debt takes into account the following factors in determining its interest rate: Inflation: Since the lender is deferring his consumption, he will at a bare minimum, want to recover enough to pay the increased cost of goods due to inflation. Because future inflation is unknown, there are three tactics. Charge X% interest 'plus inflation'. Many governments issue 'real-return' or 'inflation indexed' bonds. The principal amount and the interest payments are continually increased by the rate of inflations. Decide on the 'expected' inflation rate. This still leaves both parties exposed to the risk of 'unexpected' inflation. Allow the interest rate to be periodically changed. While a 'fixed interest rate' remains the same throughout the life of the debt, 'variable' or 'floating' rates can be reset. There are derivative products that allow for hedging and swaps between the two. Default risk: There is always the risk the borrower will become bankrupt, abscond or otherwise default on the loan. The risk premium attempts to measure the integrity of the borrower, the risk of his enterprise succeeding and the security of any collateral pledged. For example, loans to developing countries have higher risk premiums than those to the developed government due to the difference in creditworthiness. An operating line of credit to a business will have a higher rate than a mortgage. Creditworthiness of businesses is measured by bond rating services and individual's credit scores by credit bureaus. The risks of an individual debt may have a large standard deviation of possibilities. The lender may want to cover his maximum risk. But lenders with portfolios of debt can lower the risk premium to cover just the most probable outcome. Deferred consumption: Charging interest equal only to inflation will leave the lender with the same purchasing power, but he would prefer his own consumption NOW rather than later. There will be an interest premium of the delay. The discussion at time value of money. He may not want to consume, but instead would invest in another product. The possible return he could realize in competing investments will determine what interest he charges. Length of time: Time has two effects. Shorter terms have less risk of default and inflation because the near future is easier to predict. Broadly speaking, if interest rates increase, then investment decreases due to the higher cost of borrowing (all else being equal). Interest rates are generally determined by the market, but government intervention - usually by a central bank- may strongly influence short-term interest rates, and is used as the main tool of monetary policy. The central bank offers to buy or sell money at the desired rate and, due to their control of certain tools (such as, in many countries, the ability to print money) they are able to influence overall market interest rates. Investment can change rapidly to changes in interest rates, affecting national income. Understanding the relationship between interest rates and investments Interest rate and investment both have a strong relationship with each other. Different economic factors also affect the interest rate. Both short- and long-term interest rates are affected by economic factors such as inflation, the strength of the rupees and the pace of economic growth. For example, strong economic growth due to more investment can lead to inflation. If the state bank becomes concerned about inflation, it may attempt to cool the economy by raising the funds rate’ On the other hand, if the economy seems to be slowing, then it may lower the funds rate to stimulate economic growth, Economic factors also affect long-term interest rates. It should be noted that short- and long-term interest rates don't necessarily move in tandem. So the sbp may raise the rate to keep inflation in check or lower it to stimulate the economy. Affect of interest rate on bond prices Interest rates and bond prices have an inverse relationship. As illustrated below, when interest rates rise, bond prices generally fall. Conversely, when interest rates decline, bond prices tend to rise. Interest Rates and Bond Prices Have an Inverse Relationship When rates go up, newly issued bonds come to market with higher yields than existing bonds. The newly issued bonds are more attractive than comparable existing bonds with lower yields. In order to sell their existing bonds, investors will likely reduce their prices to make them equally attractive. Generally speaking, the prices of longer-term bonds are more sensitive than shorter-term bonds to changing interest rates. Similarly, fixed income funds with longer average maturities tend to be more sensitive to interest rate changes than funds with shorter average maturities. Interest rate and business Generally changes in interest rates have an effect on consumer confidence. Only when people are reasonably confident about their own financial position will they be willing and able to enter into large scale purchases. Higher interest rates have a negative effect on consumer confidence - lower rates have the reverse effect, although again there are time lags to consider. Firms take interest rates into account when deciding whether or not they go ahead with new capital investment spending. A fall in interest rates should help to increase business confidence and raise the level of planned fixed investment Some discussion about the risk Whenever we invest in any security or in bond or any where the risk is always there. The interest risk is the danger that shifting market interest rates can reduce the net income. Bond prices are affected by interest rate changes. Bond prices, and thus a bond fund's share price, generally move in the opposite direction of interest rates. As the prices of bonds in a fund adjust to a rise in interest rates, the fund's share price may decline Talking about the investment in stock market i.e. in shares So far I have talked that how the companies invest by using the different portfolios of securities. Definitely the risk factor is minimized but there are some investors, which individually invest in the stock market with the help of stock brooker. If the investor can afford to take some risk and have the ability to endure the market’s ups and downs, equity investments may grant him good returns. The investor invest in stocks and shares with the aim to buy at low and sell at high. Knowing when is however, the problem. Many investors attempt to time the market: they try to figure out when the market is going up and buy before it does and then anticipate when it is going to crash and sell before that. Usually we try to buy when the upswing has begun and sell as the downswing starts. However, such accuracy is extremely difficult to achieve. The market interest rate definitely affect the investment decisions of the investor in the stock market. When the interest rate rise the share prices fall and when the interest rate fall the share price rises. So it is very important for an individual investor to consider these things. Investors can choose to make their own dealing decisions or take advice from a professional. Buying and selling shares and tracking their performance can be time consuming but it is rewarding for those who have the time to manage their own investments. Some investors deal with stockbrokers directly while others prefer to use the services of professional managers who have discretionary powers to manage the investment portfolio to minimize the market interest rate risk. Study of the organization: Pakistan Kuwait investment (Private) Company Limited Introduction of the company Pakistan Kuwait Investment Company (Private) Limited is a leading Financial Institution engaged in investment and development banking activities in Pakistan. Pak Kuwait is a 50:50 joint venture between the Governments of Pakistan and Kuwait and was established in 1979 with a paid-up capital of Rs. 250 million contributed equally by the two joint venture partners and over the years paid-up capital has increased manifold and currently stands at Rs. 6 billion. Pak Kuwait is the highest capitalized Development Financial Institution operating in the country with a net worth in excess of Rs. 11 billion. It is a progressive organization that provides attractive return on investment to its shareholders. This is also evident by its impressive history of dividend payouts, which amounted to Rs. 9.232 billion since the time of its inception. The company’s strength lies in its strong business relationships within Pakistan and Gulf region. The driving force behind Pak Kuwait’s success has been its organizational structure, professional excellence of management, sincerity of its leadership and keen participation of the Board of Directors in the company matters. The Government of Pakistan and the Government of Kuwait has also provided its full support and cooperation from the inception to-date, which is the main source of strength for the management to operate the company professionally on sound grounds Investment function of the company Investment Banking Function is evolving into a complete financial solution provider specializing in development of Greenfield projects, Merger and Acquisitions, Debt Syndications and Private Equity Placements. The Investment Banking team at PKIC is focused, goal oriented and committed to its objectives. Each Single transaction is treated individually and tailored made in accordance with the requirements of the client. Their teamwork, passion and innovative approach towards transaction management distinguish them from the rest of the industry. Capital Markets: Capital Markets Department works with the objective of increasing the participation of Pak Kuwait in the securities markets of the country and thereby contributing to profitability of the company. Management of resources assigned to capital markets. Achievement of tax efficient sources of income, i.e. Capital Gains and Dividends. Reduction of risk through diversification Development of fee based sources of income through investment advisory business. Encouraging stock market activities by extending cooperation in Initial Offerings, Pre Initial Public Offerings, Underwriting and sponsoring Mutual Funds Establishment of Open End and Close End Fund Earning Financial income and Variable income Corporate finance: Corporate Finance Department is responsible for establishing and maintaining relationships with clients for funded and advisory business. The activities undertaken by the department are: Soliciting, developing, and maintaining relationships Selling credit/non-credit based products and services Maximizing profitability to meet the financial targets/goals Implementing the company's income budget Ensuring adherence/achievement of revenue targets Keeping a very close watch on the dynamics of market risk parameters Liaison with the Risk Management Department in screening of target markets and customers Risk management function of the company The objective of the risk management department is to Establishment and adherence to stringent Risk Management guidelines and operating parameters is the key behind Pak Kuwait's sterling achievements over the years. Pak Kuwait's Management has a clear appreciation of the Credit Risk and interest rate Risk functions and has engineered requisite operating parameters to manage the distinct risks within acceptable limits. All potential business proposals ( Credit Memorandums ) are carefully screened by the Senior Management Review Committee (SMRC) and only those which meet Pak Kuwait's strict internal credit guidelines/criteria are put forward for approval to the Executive Committee or the Board. Furthermore, the portfolio is strategically diversified with exposure in various industries i.e. Fertilizer, Pharmaceutical, Textile, Cement, Energy Sector, etc. Market Risks and interest rate risk arising from business activities are monitored and managed by the Asset & Liability Committee (ALCO). ALCO provides strategic direction in relation to Balance Sheet Management and the approach followed is to offset undesirable risk by combining the strength of Pak Kuwait's balance sheet with business unit strategies.
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