KAZAKHSTAN INSTITUTE OF MANAGEMENT, ECONOMICS AND STRATEGIC RESEARCH
Personal Savings and Investments in Kazakhstan. Introduction of Options into Investment Portfolio
by Seilkhanov Gaziz, 20074614
Instructor Altay Mussurov
Almost all the books in microeconomics have at least one chapter that is devoted to investments and capital markets. Personal income is distributed between savings and consumption. And the sensitivity of each person to consumption and savings is described by marginal propensities to consume and save respectively. On the macroeconomic level, the greater is the marginal propensity to save – the wealthier is the economy. In this paper, the author tries to concentrate readers’ attention exactly on savings.
Households are the primary suppliers of savings and funds to the loanable funds market. So the investments to any of the projects are financed by these households. Every person or every family contributes to the creation of investment funds or any other financial institutions, since it is quite difficult to invest anywhere separately.
According to theories in financial economics, it is better to invest in at least thirty or fourty assets in order to minimize or even liquidate the risks associated with investments. () Hereby, any investor creates his/her own investment portfolio, where different securities co-exist with risk-free assets and indices.
It is also possible to include currencies in the portfolio, as they have got huge liquidity properties. But the currencies market seems to be the riskiest one, since almost any factor can influence the exchange rates, thereby causing significant volatilities. In addition, numerous commodities can be also included in the portfolio. Overall, it can be said that every tradable asset can be put in the portfolio, as long as it does not contribute to the increase of the portfolio risk.
ANALYSIS OF PORTFOLIO CREATION
Theoretically, there are a lot of approaches to the formation of the investment portfolio, such as Capital Asset Pricing Model, Asset Pricing Theory, etc. In practice, investors are convinced that the overwhelming majority of these methods do have some biases that lead to wrong investment decisions. Those biases are associated with personal irrationalities, asymmetric information, security selection, and so on.
Any particular investment decision is dependent to particular person’s attitude to these investments. In general, it is considered that people are risk-averse, so it is implied that whether there is a choice between high return from risky asset and stable low return from riskless asset, one would choose the latter.
However, it is also essential to realize how the financial markets are developed in a particular country. Since the USA has a rich history of financial markets, it is considered to have one of the highly developed financial sectors. On the other hand, Kazakhstan is an emerging market economy, and the financial sector is developing, which means that there are not enough conditions yet. Not all financial instruments and tools are available. There is a high inflationary climate, lack of necessary liquidity. Assuming all these lacks, people are not able to access this market.
As long as Kazakhstan is an emerging market economy, everything is about to be introduced. According to traders and colleagues of the author, Kazakhstani market lacks the financial derivatives that greatly add to the development of financial sector. The wide use of options and futures all over the world allow investors to hedge themselves against risks. These derivatives are at the same time the shelters that protect from uncovered fluctuations of the market. Further research and studies in financial engineering conceived new approaches and instruments that allow even make profits from those instabilities. Such new tools as straddles, strangles, collars, and other instruments help investors take benefits from every sort of situations in the market.
There exists a well-known opinion, which states that if an investor buys an index (e.g. Nasdaq, S&P500, etc.), he/she is buying the world. In addition, he covers all the firm specific risks. However, even indices sometimes suffer economic recessions; therefore it is quite logical to combine those indices with securities that negatively correlate with the market.
Efficient market hypothesis states that there is no opportunity for arbitrage, which is doubtful in reality. Markets are not transparent; there is a certain level of asymmetric information, time lags, and a significant proportion of speculative activities in markets. If in theory it is stated that no effective price is available, actually it is not so. Due to high level of insider information, investors often make unprecedented amounts of money. Therefore, in a real world, there are usually certain conditions for arbitrage.
Assuming all the things mentioned above, if an investor anyways decides to create and run his/her own investment portfolio, then there are some stages, in which different aspects of investing are mentioned. First of all, an investor decides when to invest. According to Fischer Separation Theory (which is applied in a reality), an investor defines for himself whether he is better-off spending at this period of time or the next (usually there are two periods of time: now and next). This approach defines also how an investor is patient. Usually, the sensitivity to postpone the consumption from now to the next period is actually called as “rate of impatience”.
Higher is the rate, more the investor is impatient.
Second, an investor has to find a destination, where to invest. It is important to make a fundamental analysis in order to find the sector, industry and the market to invest in. Several sectors, industries and, overall speaking, every division of the economy have its own characteristic. If some branches are highly volatile and unpredictable, then there are also some “boring”, stable branches. Again, it depends on the investor, whether to choose any of the industries, as they are attractive to different investors.
Third, and the most “mechanic” step in portfolio formation process, is the choice of instruments. Here, as traders say, it is the main field for maneuvers. Beginning from primary assets to invest in (i.e. stocks, bonds), and continuing with coverage of those assets for risk reduction (i.e. options, forwards, futures, swaps, etc.); it is the opportunity for each investor to demonstrate creativity and develop his/her own investment strategy. In practice, experienced investors use covered techniques, as they provide any transaction with collateral in terms of securities or, simply, cash. Purchase or sale of any of the derivatives is accompanied by the appropriate collateral. All these are necessary so as not to face high losses. So it is implied to have different assets in the portfolio that have been hedged against undesired shocks.