Question

As an individual investor in Malaysia, you believe the main index of Malaysia stock market, FBM KLCI (FTSE Bursa Malaysia KLCI) would decline further in the year of 2022. Given strong belief in that market trend, you aim to make a significant capital gain from the financial exchanges in Malaysia. suggest TWO (2) suitable financial instruments (ie any specific equity-based, debt-based or neither debt-based nor equity-based of financial instruments) and explain in detail on how you would apply that financial instruments in order to meet your objective effectively and efficiently.

Answer 1

As an individual investor in Malaysia with a strong belief that the FBM KLCI (FTSE Bursa Malaysia KLCI) will decline further in the year, you may consider using the following two suitable financial instruments to potentially profit from the market trend:

 

Put Options:

A put option is a financial derivative that gives the holder the right, but not the obligation, to sell a specific underlying asset (such as a stock) at a predetermined price (strike price) within a specified period (expiration date). By purchasing put options on Malaysian stocks or the FBM KLCI index, you can benefit from a declining market because the value of put options tends to increase when the underlying asset's price decreases.

 

Application:

Suppose you believe that a particular stock in the FBM KLCI is likely to decline significantly in value. You can purchase put options on that specific stock with an expiration date that aligns with your expectation of the decline. If the stock price falls below the strike price of the put option, you can exercise your right to sell the stock at the higher strike price, locking in a profit. If the stock does not decline as anticipated, your risk is limited to the premium paid for the put options.

 

Inverse Exchange-Traded Funds (ETFs):

Inverse ETFs are financial instruments that aim to deliver the inverse (opposite) performance of a specific index or benchmark. These ETFs use various financial instruments and derivatives to achieve this goal. In the context of a declining market, an inverse ETF that tracks the FBM KLCI would increase in value as the index declines.

 

Application:

You can invest in an inverse ETF that specifically tracks the FBM KLCI. As the FBM KLCI declines, the value of the inverse ETF should rise proportionally. This allows you to profit from the market downturn without short-selling individual stocks or taking on the risks associated with trading derivatives directly.

 

Important Considerations:

 

a. Risk Management: While these financial instruments offer potential gains in a declining market, they also carry risks. The value of options can decrease over time due to expiration, and inverse ETFs may not perfectly track the inverse performance of the underlying index over extended periods. It is essential to carefully consider your risk tolerance and use appropriate position sizing to manage potential losses.

 

b. Market Timing: Predicting market movements accurately is challenging. While you may have a strong belief in the market trend, it is crucial to avoid overexposure to any single strategy. Diversification and a long-term investment perspective can help mitigate the risks associated with short-term market predictions.

 

c. Professional Advice: Engaging with a qualified financial advisor can provide valuable insights and help you navigate the complexities of using financial instruments effectively in your investment strategy.

 

Please note that the use of financial instruments involves risks, and past performance is not indicative of future results. Additionally, individual investment objectives and risk tolerances may vary, so it is essential to tailor your investment approach accordingly.

Answer 2

To calculate the implicit gains or losses on the forward position, we need to compare the forward rate at which the U.S. dollars were bought (MYR/USD 4.4252-70) with the expected future spot rate (MYR/USD 4.4340-7). 

The difference between the two rates will determine the gain or loss in MYR.

Given:

Amount due: $1,000,000

Forward rate (MYR/USD) when the transaction took place: 4.4252-70

Expected future spot rate (MYR/USD) after 6 months: 4.4340-7

Step 1: Calculate the forward rate's implied spot rate (MYR/USD) after 6 months using the formula: Forward Rate = Spot Rate * (1 + Foreign Interest Rate) / (1 + Domestic Interest Rate)

Since it's not mentioned in the provided information, we'll assume the interest rates in both the U.S. and Malaysia are negligible for simplicity. Therefore, the implied spot rate after 6 months would be:

Implied Spot Rate = 4.4252-70 * (1 + 0) / (1 + 0) = 4.4252-70

Step 2: Calculate the difference between the implied spot rate and the expected future spot rate to find the implicit gain or loss in MYR:

Difference = Expected Future Spot Rate - Implied Spot Rate Difference = 4.4340-7 - 4.4252-70 Difference = 0.0087

Step 3: Calculate the implicit gains or losses in MYR by multiplying the difference by the amount due:

Implicit Gain/Loss in MYR = Difference * Amount Due Implicit Gain/Loss in MYR = 0.0087 * $1,000,000 Implicit Gain/Loss in MYR = $8,700

So, the implicit gains or losses on this forward position in MYR is $8,700. If the spot rate reaches MYR/USD 4.4340-7 in the next six months, there would be an implicit gain of MYR 8,700 on the forward position.