Chapter # 2 Sources of Indirect Investment “The Financial Institutions ”

1. Lec# 1 Chapter # 2Sources of Indirect Investment “The Financial Institutions” By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

2. What are Financial Institutions They a great source of indirect investment • Following are the most common financial institution and the great sources of indirect investment. • Investment companies/ funds • Insurance Companies • Pension Funds • Hedge funds • Commercial Banks

3. 1. Investment companies/ funds • Definition: • An investment company is a company whose main business is holding securities of other companies purely for investment purposes. • They receive money from investors with the common objective of pooling the funds and then investing them in securities according to a stated set of investment objectives. • The investment company invests money on behalf of its shareholders who in turn share in the profits and losses. They are also known as portfolios or Mutual fund companies. • They are great source of Indirect investment & managed by portfolio managers and experts.

4. Types of Investment companies There are two Main types of investment companies. Open-End Management Investment Companies (mutual funds) or open-end funds Closed-End Management Investment Companies (trust funds) or closed-end funds

5. Types of Investment companies Open-End Management Investment Companies (mutual funds) or open-end funds: A mutual fund is a type of professionally managed Investment Company that collects money from many investors to purchase securities. They are registered investment companies. Investors can buy or sell its shares at any time as and when they want. They have no fixed capital structure so one can invest according to his choice. Price of the share is not determined by demand, but by an estimate of the current market value of the fund’s net assets per share (NAV) and a commission.

6. Continued … They give units to investors against their fund Which has two prices . Offer sale price Repurchase sale price The offer price is greater than repurchase price. The difference B/W these two prices is called front load which is the profit of the company. Ex: 0ffer sale price= 10 Afg R. sale price = 9.50 Afg 10 – 9.50 = .50 Afg is front load.

7. Types of Investment companies Closed-End Management Investment Companies (trust funds) or closed-end funds: It is the same as the first but; Trust funds are mutual funds with a fixed number of shares or capital structure. Trust funds are usually listed on a recognized stock exchange and its shares can be bought and sold on that exchange. They can only issue additional shares through a new public issue. Pricing of closed-end funds is different from the pricing of open-end funds: the market price can differ from the NAV. The price per share is determined by the market.

8. Example: • Mr. Ali has Invested 50,000 Afs in mutual fund company. The offer sale price/unit is 13 Afg. And repurchase price/unit is 12.90 Afs. • Find how many units has he gotten? • if he wants to resell the units how much will he get? • Find the profit of the company? Ans A:- 50000/13 = 3847 units

9. Assignment • Mr. Ali has Invested 90,000 Afs in mutual fund company. The offer sale price/unit is 15 Afg. And repurchase price/unit is 14.90 Afs. • Find how many units has he gotten? • if he wants to resell the units how much will he get? • Find the profit of the company?

10. Lec# 2 Calculating Net Asset Value (NAV) By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

11. How to find ( decide ) Repurchase price(Net Asset Value) And offer Sale price?? • It is a 5-steps process : 1. Find the total investment in assets. • ( A + B + C + D + E = T) 2. Find total net assets. • (Total Inv- Total fund related liabilities= T.N.A) 3. Find net assets value/ Repurchase price/ unit. • ( T.N.A / total units purchased ) 4. Find the front load . • Repurchase price× %/100= front load 5. Find the offer sale price. • Repurchase price + Front Load= offer price

12. How to find ( decide ) Repurchase price(Net Asset Value) And offer Sale price?? Suppose Mr. A invested 5000 @30.45 per share , Mr. B invested 10000 @ 25 per share, Mr. C invested 12000 @ 15.40 per share, Mr. D invested 15000 @ 10 per share and Mr. E invested 8000 @ 20 per share. Front load is 3% and Total liabilities are 1500 Afs. Find Repurchase and offer price per unit? Hint follow the steps.

13. Assignment to be done on paper • Suppose Mr. A invested 15000 @20.50 per share , Mr. B invested 13000 @ 23 per share, Mr. C invested 10000 @ 15 per share, Mr. D invested 25000 @ 10 per share and Mr. E invested 80000 @ 5.50 per share. Front load is 2% and total liabilities are 2500 Afs. • Find Repurchase and offer price per unit? • Hint follow the steps.

14. Lec# 3 Financial Institutions“Insurance Company & pension funds” By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

15. 2. Insurance Companies A contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an insurance companyis called insurance. A business that provides coverage, in the form of compensation resulting from loss, damages, injury, treatment or hardship in exchange for premium payments. They are in the business of assuming the risks of adverse events (such as fires, accidents, etc.) in exchange for a flow of insurance premiums. Insurance companies are investing the accumulated funds in securities (treasury bonds, corporate stocks and bonds), real estate.

16. Continued….. An insurance company can specialize in one type of insurance, such as life insurance, health insurance, or auto insurance, or offer multiple types of insurance. For example, in a car insurance policy, the insurance company agrees that if the car is damaged, the insurance company will pay the cost of repairing it. Under an income protection policy, the insurance company agrees that if its client is unable to work, the insurance company will pay its client an agreed amount.  Regulation is typically designed to protect policyholders from losses, or expand insurance coverage in the state.

17. Principles of insurance companies There are seven basic principles all insurance companies are subject to: • There must be a relationship between the insured and the beneficiary. Further, the beneficiary must be someone who would suffer if it weren’t for the insurance. • The insured must provide full and accurate information to the insurance company. • The insured is not to profit as a result of insurance coverage. • If a third party compensates the insured for the loss, the insurance company’s obligation is reduced by the amount of the compensation.

18. Continued … • The insurance company must have a large number of insured so that the risk can be spread out among many different policies. • The loss must be quantifiable. For example, an oil company could not buy a policy on an unexplored oil field. • The insurance company must be able to compute the probability of the loss’s occurring.

19. 3. Pension Funds A pension plan is an asset pool that accumulates over an individual’s working years and is paid out during the nonworking years. They came into to existence as Americans began relying less on children for care during their later years. also became popular as life expectancy increased. A fund established by an employer to facilitate and organize the investment of employees' retirement funds contributed by the employer and employees. The pension fund is a common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years and commence retirement.

20. Continued… Pension funds are commonly run by some sort of financial intermediary for the company and its employees, although some larger corporations operate their pension funds in-house. Pension funds control relatively large amounts of capital and represent the largest institutional investors in many nations. Annual Retirement Payment = 2%  average of final 3 years’ income  years of service

21. Types of pension Funds Following are common types of pension funds. Defined-Benefit Pension Plans: a plan where the sponsor promises the employee a specific benefit when they retire. Defined-Contribution Pension Plan: a plan where a set amount is invested for retirement, but the benefit payout is uncertain. Private Pension Plans: any pension plan set up by employers, groups, or individuals Public Pension Plan: any pension plan set up by a government body for the general public (e.g., Social Security)

22. Lec# 4 Financial Institutions“Hedge funds & Commercial Banks” By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

23. 4. Hedge Funds The word "hedge" means to manage risk. Or Making an investment to reduce the risk . They are unregulated private investment partnerships, limited to institutions and high-net-worth individuals, which seek to exploit various market opportunities and thereby to earn larger returns than are ordinarily available. Hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment.

24. Continued… • Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year. • They require a substantial initial investment from investors and usually have some restrictions on how quickly investor can withdraw their funds. The primary aim of most hedge funds is to • Reduce volatility and risk • while attempting to preserve capital, and • deliver positive returns under all market conditions. • Most often they hedge in foreign currencies to secure International business and trade.

25. Hedging Process

26. Characteristics of hedge fund companies Following are main characteristics of hedge funds. They Limited Liability Partnerships that provide only minimal disclosure of strategy and portfolio composition. Usually they allow no more than 100 “sophisticated”, wealthy investors . Their Investment strategy is very flexible, funds can act opportunistically and make a wide range of investments. They have limited liquidity of fund. Often have lock-up periods, and require advance redemption notices. Typically they charge a management fee of 1-2% of assets and an incentive fee of 20% of profits.

27. 5. Commercial Bank A financial institution that provides services, such as accepting deposits, giving Loans (business loans and auto loans, mortgage lending, ) and basic investment products like savings accounts and certificates of deposit. Commercial banks make their profits by taking small, short-term, relatively liquid deposits and transforming these into larger, longer maturity loans. This process of asset transformation generates net income for the commercial bank. Note that many commercial banks do investment banking business although it is not considered the main business area. A commercial bank is a bank that works with businesses.

28. Continued… A bank may also generate its profit from the differential between the level of interest it pays for deposits and the level of interest it charges in its lending activities. Historically, profitability from lending activities has been cyclic and dependent on the needs and strengths of loan customers. In recent history, investors have demanded a more stable revenue stream and banks have therefore placed more emphasis on transaction fees, primarily loan fees but also including service charges on array of deposit activities and other services (international banking, foreign exchange, insurance, investments, wire transfers, etc.). However, lending activities still provide the bulk of a commercial bank's income.

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