Advanced Equity Trading

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Advanced Equity Trading

• Gavin Bramley
• Share Direct

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Know this about every share in your portfolio

• Financial year end interims
• LDR last day to register
• Earnings Yield
• Low Highly rated
• High poorly rated
• Level of borrowings
• Profit trend (EPS)

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Finding winning shares

• Structured / organized search - wide
• Consider best sectors potential
• Narrow list with criteria
• Volume test (liquidity test) min R500.000 / day
  recommended
• Earnings Yield (Not too high or too low)
• Is share in Upward or downward trend
• Avoid Extremes share doubled..in future
• Trend (5-10 years)

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Fundamentals

• Gearing exposure
• Asset intensive depreciation
• Consumer monopoly vs commodity type
• Be interested in what they do

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Analyse Gold Mine

• Mature
• Established
• Developing
• Short life

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Principles of Fundamental Analysis

• We are principally looking at which shares we
  would want to buy, but remembering that we would
  only do so if the price is right from a business
  perspective.
• In fundamental analysis we would typically adopt
  a long-term buy and hold strategy
• Consumer monopoly vs Commodity

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Intrinsic Value

• Warren Buffett
• ..the intrinsic value of a business is the
  projected annual compounding rate of return that
  the investment will produce.
• This annual compounding rate of return is then
  compared to other investments. If the money to be
  invested can generate a higher return elsewhere
  for the same or lesser risk, then the proposed
  investment should go to that investment.
• Determine business value in 10 years
• We want to invest in companys whose earnings we
  can predict.

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Two types of business

• a commodity-type business whose earnings
  fluctuate making the task of forecasting earnings
  difficult if not impossible and
• a consumer monopoly whose earnings (EPS) can be
  forecast as they have little or no competition
  and so profitability is assured. Consumer
  monopolies are more profitable than commodity
  type businesses and hence our focus is on these
  types of businesses.

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Consumer Monopoly

• Price does not affect the quantity sold because
  it is the only firm in the market or because its
  products not substitutes for another product.
• Barriers to entry. Investment in infrastructure.
• Protected environment - Telkom
• Consumer monopolies generate large sales revenues
• Unlikely to experience a cash flow problem or to
  be in debt.
• Household names such that it would be unhealthy
  for other businesses NOT to stock products coke
  / Castle

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Commodity-type

• Competes on price
• Products are substitutes
• Needs to retain earnings to replace capital
  items. Depreciation
• May be highly geared borrows to supplement cash
  flow

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Selecting the profitable equities?Look for
consistent returns (EPS)
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Calculate the Per Share Growth Rate
HP 10 B Calculator.
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NextCalculate the Initial Rate of Return

• The earnings per share are determined by the
  performance of the company, but you must decide
  on the price that you will pay for that share
• the higher the price you pay for the share, the
  lower your internal rate of return will be
• you may have to be patient and wait for the price
  to fall before you buy if IRR is too low.

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Calculate IRR - example
The less you pay the higher IRR and visa-versa.
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Put them together
CRM as a bond would give us an initial return on
investment of 11.56 per annum but would increase
this return by 36.34 p.a.
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Predicted EPS and Share Price at ROI on
16.09.2003 of CRM
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Ensure that return on shareholders equity is
high (ROSE).
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Projected Values 10 years hence
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Buys back its own shares?

• Be warned, though, if company profits remain the
  same and you decrease the number of shares in
  circulation, the earnings per share and share
  price will go up.
• If you increase the number of shares in
  circulation, the earnings per share and the share
  price will go down.

• Management of companies know this and can abuse
  this principle to make very ordinary results look
  a lot better.
• A simple check is to compare the companies
  actual net earnings annual compound growth rate
  with the annual compounding growth rate for per
  share earnings.

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Are retained earnings being used to increase
shareholder value?

• Companies do not usually pay the full earnings
  per share as a dividend preferring to retain a
  portion for further expansion, replacing assets
  or to bolster their performance when times are
  tough.
• As investors we would want to know what
  management are doing with our profits. Are they
  using them effectively?
• My rule is, If management can use the retained
  earnings of the company effectively to generate
  further increases in the share price, then I am
  happy to let them keep those retained earnings.
  If not, then I would rather have the retained
  earnings paid to me as a dividend.

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How do I get the information?

• Identify the companies that you wish to evaluate.
• Phone them. Tell them you are managing a small
  portfolio, and that you would like to consider an
  investment in their company, but that you require
  ten years worth of financials to make that
  decision.
• Ask them to send you the information in whatever
  format is easiest for them. You may end up with
  some photocopies, but the bulk will have their
  annual reports, dating back ten years, in all its
  glossy glory.
• You might also find that this information is sold
  in the format of computer programs offering
  regular updates of all fundamental information by
  the various companies who sell stock market
  charting software.

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Rights Issues

• Raises money from existing shareholders
• Growth, premises, R D
• Cheaper than overdraft
• Interest vs. dividends from surplus cash
• Starts with S/holders meeting motion to issue
  shares decision 1 share for x held
• S/holders must note important dates.

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Rights Issues NB dates

• Last Day to Register
• Day on which eligiblity is determined for offer
• Ex-Rights date date after LDR
• Opening date of offer
• Date from which company accepts letters of
  allocation
• Closing date of offer
• Date by which letters of allocation must be
  returned

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Rights Issues Nil Paid Letter (NPL)

• Are transferable to ensure take-up
• Also offered at below market price
• NPLs have a tradable value on the stock market
  (separate listing)
• Owners of NPLs must still pay the take-up price.

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Example ( 6 for 10)
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Impact on shareholder

• Each share now worth 262.5
• Rights offer at only 200, profit 62.5
• Value of NPL is thus 62.5 being the difference
• NPLs can be geared
• After closing date NPLs are worthless

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Share price raises 20
NPL (300 200 100) Increase of 60
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Underwriting Sponsoring

• Rights issues require
• Underwriters guarantee to take up unwanted shares
  to ensure finance is raised.
• Paid a fee for doing so
• Sponsoring Broker
• Advises on structure of the issue
• Assists with getting issue accepted by JSE
  committee

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New Listings

• Requirements to list
• Certain size
• Minimum pre-tax profits
• Reasonable trading history
• Minimum number of shareholders
• Spread of shares amongst the public

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New Listings Prospectus

• To make public aware of financial position of the
  company and why it needs additional capital
• Promotes ability to make an investment decision
• Prospectus includes
• Articles of association, directors remuneration,
  borrowing powers of directors, shares application
  form, assets of the company, auditors report,
  loan capital and borrowings, statement of assets
  liabilities, profit history, subsidiaries,
  material contracts, expenses of the issue,
  brokerage fees, underwriting minimum
  subscription, dates and times of the offer

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Private Placement

• a new listing not accompanied by an offer of
  shares to the general public
• usually means the publics portion of the shares
  has been allocated by way of a private placing
• A private placing is a preferential offer to
  institutions and companies associated with the
  company seeking a listing.
• offered via a sponsoring broker
• offers enormous profit potential because
  companies that are able to arrange a private
  placing are normally high-profile

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Public Offer

• Public may subscribe
• Stag apply and sell on listing to make quick
  profit
• Oversubscribed only get a - pay 100
• Many small applications vs One large app.

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Companys reasons to list

• Cash flow
• Reduce gearing (investment vs borrowings)
• Expansion programs
• Disinvestment from a country
• May allow existing owners to realise
  (re-invested) profits. (Bull market make it
  attractive)
• Family owned Vs professionally managed

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Cycles

• Technical analysis is based on the assumption
  that share prices move in repetitive patterns
• trends, formations and cycles
• Past modules dealt with trends and formations
• We shall deal with cycles and waves
• Recall psychology

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Cycle theory

• and group investor behaviour suggests that
  natural cycles such as the seasons, the phases of
  the moon and perhaps some mystical biorhythm of
  mankind, influence investors to trade at
  predetermined intervals.
• Some cycles are obvious coal / orange juice
• Dow Theory, Elliott Wave, Kondratieff

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Difference between cycles and waves

• wave theories postulate a regular pattern
• Elliott is a wave theory
• cycle theories postulate a regular time frame.
• Kondratieff is a cycle theory

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Cycle theorists

• maintain that shares, share markets, sectors,
  commodities, exchange rates and almost every
  commercial data stream move in regular cycles.
• They suggest that cycles are repetitive and of
  relatively fixed duration making them predictable

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Three cycles moving together
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Cycles

• help to identify the lows and highs and to time
  your transactions
• use momentum indicators of different lengths
• a 5-day momentum simply takes each days price
  and subtracts from it the price of 5 days ago
• difference oscillates around zero - the more
  pronounced peaks and troughs should highlight the
  underlying cycles
• NB other cycles at work may obscure

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Cycles - warning

• Need Volume to test for cycles
• Thinly traded not enough investors at play
• One investors actions can nullify calcs.

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How do I reduce risk?

• Diversification
• Warren Buffett, one of the worlds richest men,
  cautions that diversification is something people
  do to protect themselves against their own
  stupidity

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How is this possible?

• The answer lies in the fact that these four asset
  classes do not move in perfect synchronisation.
  Their movement creates a wave-like effect, in
  that as some assets struggle, others help to push
  the portfolio along. To take advantage of this
  effect you have to periodically rebalance the
  portfolio by selling some or a portion of the
  winners of each year and investing the proceeds
  into the losers.
• The market works in cycles

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4 Assets and a Portfolio
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KONDRATIEFF
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Kondratieff

• is a wave of commodity prices rather than
  business activity levels or stock market prices.
  
• It is a cycle of inflation and deflation, not of
  boom and bust.

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Kondratieff Phase 1- spring summer

• 20 years of strong growth and rising commodity
  prices, which end with a major war.
• Associated with major technological advances and
  rising confidence.
• Businesses reach production capacity and begin to
  expand capacity.
• Over investment finally causes distortions which
  are reflected in political tensions, economic
  instability and eventually war.
• The wars referred to are the war of 1812, the
  American Civil war, World War 1 and Vietnam.
• Opponents point out that there was no World War
  2.

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Kondratieff Phase 2 - Autumn

• The war is followed by a sharp primary recession
  lasting three or four years and then by a
  decisive recovery.
• This is followed by a declining plateau of
  commodity prices where normal business conditions
  reach periods of intense prosperity.

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Kondratieff Phase 3 - Winter

• A deflationary collapse in which the money supply
  shrinks dramatically as a result of bank
  collapses.
• This draws the stock market down and general
  business activity levels decline sharply with
  spending power.

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Kondratieff

• Based on economically active lifespan of mankind
  54 years
• Deflation crash (1929) memory eventually fades,
  debt levels rise
• People need to learn from their own mistakes !
• People live longer
• Communications and derivatives
• Economic knowledge has improved lessening effects

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Kondratieff Elliott Wave
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STOCHASTIC INDICATOR George Lane

• OB/OS and momentum (oscillate around 0) can be
  misleading hence
• Marginal mine reaches OB/OS levels at /- 30
  whereas blue chip may be heavily oversold at
  -10.
• Stochastic overcomes this
• It standardizes buy and sell lines irrespective
  of their volatility using a mathematical formula
  that oscillates between 0 100

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Stochastic - Calc

• works on the principle that shares in a rising
  trend tend to close near the top of their periods
  high
• and shares in a falling trend, tend to close near
  the bottom of their periods low.

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JSE index - as the index rose higher, the share
closed closer to its high. As the bull trend
matures and loses momentum, the index closes
closer to its low.
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Stochastic determine the period

• Periods must coincide with your investment
  strategy
• ensure all indicator periods match each other to
  prevent false signals

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Example

• Close - Low x 100
• High - Low
• The following diagram best illustrates the
  formula
• When looking at share "A", notice that according
  to the formula, the value of the stochastic must
  be 100. If the low was subtracted from the high
  and the close, the answer will be the same
  because the high and close are identical.
• B 0

When the close is nearing the high of the day,
the value tends towards 100 and when the close
tends towards the low, the stochastic nears zero
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Trading the Stochastic

• To establish buy and sell lines use both the
  stochastic and the moving average.
• Sharefriend defaults to 50 (stk) and 30 (mva)
  days.
• Where the stochastic breaks down through the 80
  line and the 3/5 (of the period of the
  stochastic) moving average is also in a downward
  trend, then a clear sell signal is given.
• When the stochastic breaks up through the 20 line
  and the 3/5 moving average is in an up trend, a
  buy signal is generated.

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Breaks down 80, MVA down Sell Breaks up 20,
MVA up buy
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RSI Wells Wilder

• Internal strength index as it measures the share
  against itself.
• Originally recommended a 14 day RSI. 9 25
  gained popularity since.
• Period used will affect volatility. (Smaller
  periods are more volatile than longer periods)

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RSI - Calc

• Where U An average of upward price changes
• D An average of downward price
  changes
• The RSI is a more sophisticated momentum
  oscillator, oscillating between 0 and 100 and
  takes into account the variations that occur over
  a period of time.

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RSI - Example
12 up days and 9 down days
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RSI - Trading

• Apply either a trendline or moving average to the
  RSI.
• Any break of the trendline or moving average
  signifies a buy/sell point.

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Also.

• RSI also shows when a share is overbought
  /oversold
• above 70 - the share is overbought and below 30
  it is oversold. Any break up/down through the
  30/70 levels, respectively, is a buy/sell signal.
  

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RSI Example 1
The graph represents a 21-RSI with a 14-day MA
and the closing graph of Sasol. Looking at the
buy/sell signals generated by the RSI, see that
they match the cycles of the closing graph,
offering a number of trading opportunities.
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RSI Example 2

• The other method of interpreting the RSI is to
  buy when the indicator is at 30 and to sell when
  the indicator is at 70. The RSI often provides
  buy/sell signals prior to share price movements.

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MAC-D (Intro) - Gerald Appel

• MAC-D is a lagging indicator.
• a trend following momentum indicator that shows
  the relationship between two moving averages of
  prices.

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MAC-D (Calc)

• The MAC-D is calculated by subtracting the value
  of a 50-day exponential moving average from a
  21-day exponential moving average.
• A 9-day moving average, called the "signal" line,
  is plotted on top of the MAC-D to show buy and
  sell opportunities.

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MAC-D Trading

• The MAC-D is a "Trending Indicator" and proves
  most successful on a long-term view. There are
  three popular ways to interpret the MAC-D
• Crossovers
• Overbought/Oversold conditions
• Divergences

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MAC-D Crossovers

• The basic rule is to buy when the MAC-D crosses
  up through the signal line and sell when the
  MAC-D crosses down through the signal line.
• It is also possible to use the MAC-D as a buy and
  sell signal when it crosses up and down through
  the zero line (there would be a greater lag if
  this was done).

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MAC-D (overbought/oversold)

• The MAC-D is also useful as an overbought/
  oversold indicator.
• When the shorter moving average pulls away
  dramatically from the longer moving average
  (i.e., the MAC-D rises), it is likely that the
  share price is over extending and will soon
  return to more realistic levels.
• MAC-D overbought/oversold levels vary from share
  to share.

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MAC-D (Divergences)

• The current trend is near an end when the MAC-D
  diverges from the share price.
• A bearish (negative) divergence occurs when the
  MAC-D is making lower highs while the share price
  graph makes higher highs.
• A bullish (positive) divergence occurs when the
  MAC-D is making higher lows while the share price
  continues to make lower lows.
• Both these divergences are most significant when
  they occur at relatively overbought/oversold
  levels.

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MAC-D Graph 1
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MAC-D (Example)

• Notice that buy and sell signals were plotted on
  the price graph every time the MAC-D crossed
  through the signal line.
• This does not give a good trading pattern
• Success was only generated when the MAC-D crossed
  over the signal line in oversold (below zero) or
  overbought (above zero) territory (that is five
  trades for the period next ..).

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MAC-D Graph 2
When the MAC-D indicator is rising, hold on to
the share (trending indicator) and when the MAC-D
is falling, trade the share (use trading
indicators).
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Standard Bank Buy sell lines
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Elliott Wave
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A Traders Trading Rules

• Learn how to take your losses quickly and
  cleanly.
• Dont expect to be right all the time.
• If you have made a mistake, cut your losses as
  quickly as possible
• of the greatest traders never rely on more than
  two or three core indicators and never listen to
  the opinions of others.

• Ignore the news media.
• Determine the stock or stocks to trade in
• 4 loss rule
• It is better average up than to average down.
  
• Know when to get out before you get in
• When in doubt, do nothing.
• Never be sentimental about a stock.

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Trading Rules

• Use stop loss orders
• Trade with the trend. The trend is your friend!

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Watch List

• 800 companies on the JSE
• Watch list of (Buffetology) shares
• Diversify with 5-15 shares
• Reduces risk upto 15 shares

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Dividends

• On the day following the last day to register for
  a divided (also known as the ex-div date), the
  share price should fall by exactly the amount of
  the dividend.
• Such a sudden fall in the price of the share
  could push it through your stop-loss level.

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Averaging Down

• Admit you got it wrong
• Danger is that it keeps falling
• Stop out and wait for the next opportunity

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Risk and Return

• Big Dog syndrome
• Higher return implies higher risk
• Diversify
• Manage losses, profit will take care of themselves

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Portfolio Structure

• Four main areas
• Blue Chips
• Growth
• speculative
• Warrants / Equity Futures
• cautious of subjective warrant (option) pricing,
  prefer to offer leveraged IEFs, which are a more
  effective and cost efficient mechanism to
  leverage or to hedge
• a safe, long-term, low-return area a medium-term
  growth area and a high-risk, short-term area

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Warrants and Volatility

• most important aspect of warrant pricing is the
  calculation of the volatility of the share
  itself.
• Market makers (options) bet on the volatility of
  the asset either rising or falling whilst
  constantly maintaining a neutral position in the
  asset itself.
• when you buy a warrant, you are buying the
  underlying volatility of the asset. If volatility
  falls, you are at risk, regardless of the move in
  the price.
• EG You could buy a put warrant and the share
  price falls but the price of the warrant remains
  the same due to a change in volatility.

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IEFs

• The warrant situation cannot happen
• Either right or wrong in your view and profit /
  loss based on a change in price of the underlying
  share
• No time decay effects either
• IEFs less complex than warrants
• A 1c move in share price 1c change in IEF price
• Leveraged
• Not subjective (as is volatility)

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IEFs

• Open Safex account (24 hrs)
• Afrifocus will monitor your account daily (20
  margin)
• Top 40, most of Indi 25 can be traded
• Shorts!!!
• delta means portfolio is geared to a rising
  market, - delta means you are short the market

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IEF - Example
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IEF Additional info

• Although the initial margin cost of the IEF is
  R12,000, the total margin deposit would be
  R22,000 in order to cover any variation margin
  requirements should the price of Sasol have
  fallen.
• Margin deposits earn interest at the SAFEX rate.
• The effects of leverage using IEFs are clear. It
  is therefore important to note that the downside
  risk can also be severe.

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Note Prices used as at 10/09/2002
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IEFs (Volatility repricing)

• SAFEX generally recalculate the initial margin
  prices about every 3 months according to historic
  volatility counts. Therefore, as prices change,
  the effective gearing levels will fluctuate too.
  As a rule of thumb, the average gearing is about
  8 times.

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Planning your strategy

• Geared or ungeared
• Warrants
• IEFs
• Longs
• Hedged or not
• Warrants
• IEFs

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Warrants

• Is an option, providing the holder with the right
  but not the obligation to buy (or sell) the
  underlying asset on or before a specified date.
• Calls
• Puts
• American before or on exercise date
• European exercised on the date only

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Warrant Terminology

• Underlying assets
• This is the asset on which the warrant is written
  e.g. a currency or share
• The issuer
• This is the institution which writes the option
  e.g. STD Bank, Deutsche Bank, Gensec or Investec
• Strike price
• This is the price at which the warrant holder can
  either buy or sell the underlying asset.
• Maturity Date
• The date on which the warrant is to expire.
• Time decay
• Also known as theta to the Greeks. In short this
  means that a warrant looses value with every
  passing day.
• Premium
• This is the Price paid for the warrant

• Cover ratio
• This is the number used to determine how many
  shares in the underlying share as warrant holder
  you are entitled to. Example, 101, the warrant
  holder would be entitled to 1 share for every 10
  warrants held.
• Delta
• If a warrant has a delta of say O.5, it means
  that the warrant has a 50 chance of being in the
  money at expiry.
• Gearing
• Accelerates potential profit
• In the money
• Share price is past the strike price in the
  direction that leads to profit
• Out the money
• Share price has not reached the strike price in
  the direction of profit

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Call Warrant
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Put Warrant
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Advantages

• Costs less than underlying share
• Can limit losses to cost of option
• Small downside, higher upside
• One stock may have many warrants to choose from
• Puts (shorting), calls, time periods

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Comparing Costs
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Trading the ups and downs
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Influences on Warrant Price
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The Greeks
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Delta
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Delta
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Effective Gearing
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Impact of Dividends
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Interest Rates
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Matrix
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Intrinsic Value
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Interest Saving
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Matrix Pricing
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Price Determinants
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Trading Warrants
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Tips
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Tips part II
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Currency Trading

• What is Forex?
• 24 hr market
• USA open is NB!
• Quoted in pairs
• 1st currency is base currency
• 2nd called the counter

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Forex

• Bid and ask quoted in real time ensures fair
  price
• USD/JPY Bid _at_ 131.40 Ask _at_ 131.45
• 5 pip spread defines cost!
• Margin good faith deposit against trading
  losses. Allow gearing/leverage of 1001
• Rollover interest is charged on daily positions
• Profit in up or down market
• Deal direct with market maker reduces
  transaction costs
• Great for technical analysis due to volatility

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Futures

• Originate 16th century
• Secured prices and stock 12 months ahead
• If one party reneged the deal collapsed

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Exchange facilitates

• Facilitates trading brings counter parties
  together
• Liquidity parties are able to trade (close out)
  their positions at any stage
• Prices reflect market conditions
• Margins reduces risk

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Futures contract defined

• An agreement and obligation to buy (a long
  position) or sell (a short position)
• A standard quantity (called contracts.)
• Of an asset (commodity/financial)
• On a specified date (expiry date)
• At a price determined at time of entering into
  the contract.

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SAFEX (South African Futures Exchange)

• A non profit association
• SAFEX can be seen as a huge on line market
  computer and connected to the computer are
• Clearing member
• Represent a financial institution with a net
  worth of R20 million and have further guarantee
  of R10 million
• Each provide R250 000 to guarantee loan fund
• Have a position limit with SAFEX (their
  guarantee)
• Maintain the integrity of the system
• Non clearing member must be affiliated to a
  clearing member
• SAFEX is therefore the guarantor to every
  transaction in other words, they become the
  buyer to every seller and the seller to every
  buyer, thereby taking the risk of non-payment
  away.
• Interest is received on margin at a competitive
  rate.

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Financial Futures

• This is a contract where the underlying asset is
  a financial instrument, currency, notional asset
  or equity and the contact price depends on an
  interest rate, yield or share index. All
  financial futures are cash settled.
• The following financial futures are traded in
  RSA.
• Stock index futures All Share Index
• Industrial Index
• Financial Index
• Mining Index
• Long Bonds E168
• R150, R153, R162
• Currency futures Rand-Dollar (foreign account
  holders only)

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Stock Index Futures

• 1. Underlying asset
• This future contract is based on some of the
  major indices on the JSE
• An index is a basket of shares.
• The index is normally compiled on a weighted
  basis (price moves of the larger shares will have
  a greater impact on the index than moves of the
  smaller shares).
• An index is used to track performance and trends.
• With the buying and selling of futures investors
  can participate in the movement of these indices.

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Margin

• Not a transaction cost, but a payment to SAFEX to
  minimise risk
• A fully refundable amount provided profits are
  earned.
• Initial margin depends on the type of contract.
• Margin usually ranges between 5 and 10 of the
  contract value, but volatility plays a major role
  in this pricing system.
• Margins are set equal to the greatest loss that
  position could reasonably be expected to occur
  from one day to the next.
• For example, the September Indi allows for a move
  of 800 points (R8000/R10)
• Initial margin must be deposited before the
  opening of the next day after your trade.
• Daily losses must be met by the client by
  depositing further collateral, known as variation
  margin, into his/her account.
• This is required by the close of business the
  following day.
• In the same manner, profits are added to your
  account.

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Futures

• Tick Size
• This minimum price movement in a futures contact.
  
• For example
• SAFEX
• 1 point R10
• S P 500
• 0.05 point 25
• FTSE
• 0.5 point 12.50

• Broking Fees
• Low compared to equity transaction, but once
  again you must shop around for fees that suite
  you.
• For the small client (gt100 contracts/month) R70
  per round turn for an exposure of R70 000 you
  will pay 0.1 broking fees
• For the larger client (gt100 contracts/month)
  R50 per round turn for an exposure of R70 000
  you will pay 0.7 broking fees.

130
Futures

• Closing out of futures contracts
• Occurs when you want to get out of a position.
• Liquidity is important
• Contracts can be closed out with an equal
  opposite contact any time.

• Expiry day / close out day
• The expiry date of the contract.
• Four expiry dates per year usually the first
  business day after the 15th of March, June,
  September and December.
• On this day the future and the index (spot)
  become the same, in other words, the basis
  becomes zero
• All contracts are closed out, unless rolled over.

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Futures

• Mark-to-market (M-t-M)
• SAFEX extracts a value form the future market on
  a daily basis this figure is known as the
  M-t-M.
• The M-t-M is taken at 16h30 each day at mid pint
  of the best dib and offer prices.
• Depending on the move the futures from the time
  of your transaction to the M-t-M the buyer or
  seller will make a profit/loss.
• A cash settlement will be made on the following
  business day.

• Cash settlement
• Since we cannot deliver an index/basket of share,
  cash is used as a substitute.
• Profit or loss made by the buyer of the future
  contracts exactly equal to the profit or loss
  made by the seller of the contract known as a
  Zero Sum Game.
• The amount of profit/loss to be settled between
  the two parties would be the difference between
  the agreed contract price when entered and at the
  time it was closed.

132
Futures

• Pricing of futures
• Generally speaking, there are 3 elements that
  determines the price of a future contract, i.e.
  its fair value (FV)
• Spot price of the underlying asset (counts the
  most)
• Financing costs (e.g. interest, storage and
  insurance)
• Income generated by the underlying asset
• Therefore, FV spot financing costs income
  from asset.

• Supply and demand can cause the actual future
  price to be at a premium or discount to the FV.
• The difference between the futures price (FP) and
  spot is known as the basis
• If FP gt spot gt future is at a premium to spot
  and is called contango.
• FP lt spot gt future is at a discount to spot and
  is called backwardation.

133
Pricing a stock index future

• The following factors are taken into account
• Current spot index value (index value tick
  value)
• Dividends paid on shares making up the index
• If person had bought a basket of shares dividends
  would accrue this income is lost by buying a
  future.
• Short term interest rate
• A person buying a basket of shares would have to
  borrow or reduce cash. They save this interest
  cost by buying a future.
• time until maturity of the future

• Therefore, FV 1 (1r/100 DY/100) compounded
  by d/365
• Where,
• FV fair value of the future
• I current value of the spot index 10
• R short term interest rate per annum
• DY dividend yield paid on shares making up the
  index
• D number of days until expiry

134
Trading Procedure

• Investor places an order with the broker
  (clearing or non clearing member) and stipulates
  his/her price
• Broker discusses with the client whether the
  price is plausible
• Trade takes place, one party buys (long position)
  and the other party sells (short position)
• Both buying and selling brokers enter the deals
  into the SAFEX computer
• The positions are registered in the names of the
  each party
• SAFEX sends a note to each party confirming their
  positions
• Contract holders wishing to maintain a position
  may roll it forward into next expiry month. A
  new contract has to be entered into.

135
Bonds

• A bond is a long-term loan that is made by an
  investor to the issuer of the instrument. The
  terms of the bond covenant oblige that the issuer
  (the borrower) will make regular interest
  payments to the holder of the bond
  (lender/investor) on predetermined dates
  throughout the lifespan of the bond and on
  expiration, repay the capital.

136
Bonds time to maturity

• is the number of years over which the issuer of
  the bond has contracted to meet its payment
  commitment
• issued with a fixed maturity or redemption date
  on which the nominal value of the bond is repaid
• one to three years (short term),
• three to ten years (medium term) or
• ten to thirty years (long term)
• TTM has a direct impact on the risk and
  ultimately the return (yield) of a bond

137
Bonds

• Face Value
• also known as par value, principal or maturity
  value
• Value of the bond on expiration (usually R1M)
• When a bonds price is below face value it trades
  at a discount, if above, it trades at a premium

• Coupon Interest
• is the fixed interest, expressed as a percentage
  the issuer agrees to pay each year
• Calculated on the face value of the bond
• EG bond with 14 coupon rate pays R140 on a bond
  with a R1000 face value

138
Final Terms