Vision Finance
Report prepared by Paul Mahoney S3356863
BAFI2112 Financial Markets Study Period 3

|Financial Markets Report |Submitted 18th November 2011 |
| |Client Name:BHC |
|Executive summary |Scenario One: Financial Investment Advise|
|The current investment market is a hazardous environment for all stakeholders involved as a result of | |
|recovering investor confidence post-global financial crisis (GFC) and with the possible effects of the | |
|European credit crisis. It is therefore essential to analyse current expert opinion, economic factors and | |
|interest rate forecasts when selecting an optimal investment strategy. Vision Finance provides this | |
|analyses and a specified expert opinion for BHC given their current need for investment of funds in the | |
|Australian money and debt capital markets within this report. | |

Table of Contents

Executive Summary ................................................................................................................ 1
1. Introduction ......................................................................................................................... 3
2. Market Analysis .................................................................................................................. 4
2.1 Market Condition .............................................................................................................. 4
2.2 The Market and Suggested Strategy .............................................................................. 6
3. Conclusion ............................................................................................................................ 8
List of References .................................................................................................................... 9

1. Introduction

This report aims to provide BHC with a market overview and investment strategy for the AUD$350m the company will receive in the coming weeks. It will analyse current economic trends, the yield curve and future interest rates to determine the most effective options for the investment of these funds in both the Australian short-term money market and longer-term debt capital market. The report will leave the BHC CEO and senior management with a clear strategy for investment based on key economic factors and current world events. Issues such as the Global Financial Crisis (GFC) and the European sovereign debt crisis are critically important for consideration to all investment portfolios. Investors must learn lessons from events such as the GFC and be wary of the possible recurrence of such losses. Vision finance will identify the current forecast of interest rate movements as predicted by a number of leading industry experts and give recommendations of our own expert opinion. Based on all of these factors this report will identify ways in which BHC may take advantage of these forecasts in its investment portfolio. Investment options are extremely broad however this report is limited to the investment of funds in the Australian money market and debt capital market.

2. Market Analysis

2.1 Market Condition
Since the GFC market conditions have been highly variable due to fluctuations in the economic system including economic growth, full employment, price stability, external balance, efficient allocation of resources, and equitable distribution of income and wealth. All of these factors influence the current Australian yield. Australia’s yield curve is determined by the yield on risk-free Commonwealth treasury bonds and is widely regarded as a key indicator of the future direction of interest rates. The yield curve identifies the yield on these bonds of differing maturities and hence indicates forecast interest rate movements.(Kaufman 2011).
[pic]
(Fureyous 2010)

The above yield curve shows the returns available on bonds of differing maturities and is a good indication of the future direction of interest rates. This particular graph also shows the current volatility in the market with the yield changing on a fortnightly basis. Note that on all these curves above the yield is falling significantly over the next 12 month period.

The current Australian market condition can be best described as two speed with the resources sector experiencing significant investment with more to come. However at the same time other sectors such as retail have dampened somewhat due conservative household spending and the increased exchange rate. Inflation remains within the Reserve Bank of Australia's (RBA) target range of 2-3 percent (RBA 2011). Unemployment has risen slightly to 5 percent however Westpac predicts that it will rise to 5.7 percent by the end of 2012 which indicates a further 100 000 people unemployed (Colebatch 2011). Financial conditions have been easing with interest rates on lending falling slightly and competition to lend increasing. The overall condition had remained relatively tight with borrowing rates higher than usual, credit growth slowing and asset value falling throughout the year. The exchange rate has been highly variable over the past 12 months however sits historically high. For the majority of 2011 the RBA maintained a slightly restrictive monetary policy due to inflationary concerns. However with inflation constrained in all areas other than resources the RBA is now confident with a neutral monetary policy stance and hence the 25 basis point cut from 4.75 percent to 4.5 percent on the 1st November 2011 (RBA 2011). The RBA also revised its forecast for growth and inflation for the next two year period. The treasurer recently stated that there was room to move in Australia when it comes to monetary and fiscal policy. As a result of our nation being in a much stronger position then its counterparts. (Shamim 2011)

The biggest current risk to the economy is the European sovereign debt crisis and due to its ability to negatively impact on financial markets there is the possibility for further rate cuts. (Glynn 2011). However if the European crisis is resolved and the exchange rate falls there is likely to be some degree of inflationary pressure as a result of increased consumer confidence and domestic spending which could result in an upward movement in interest rates by the RBA. A number of economists are forecasting further rate cuts throughout the next 12 month period due to the state of the non-mining economy, rising unemployment and Australia’s comparatively high interest rates. This is seen by some as a must to avoid a damaging contraction. A further contribution to this contraction is the impact on consumer confidence of the looming carbon tax which is reportedly at its lowest level since the GFC (Colebatch 2011). RBC capital markets is one of said economists and are forecasting three further cuts, including two 25 basis points and one 50 basis points, over the next 12 months to an estimated 3.75 percent cash rate to provide a more accommodating stance such as that adopted in the Asian region. (Shamim 2011)
As a result of reviewing these expert opinions, the economic factors and the current government bond yield curves it is forecast that interest rates will continue to fall for the coming 12 month period. This needs to be considered when determining investment options for BHC.

2.2 The Market and Suggested Strategy

Given the current market view and BHC’s need to invest the sum of AUD$350m, Vision Finance will detail and recommend suitable Australian money and debt-capital market products. The economic factors contributing to the market conditions must be considered to optimise the choice of investment options.

BHC should utilise a portion of cash products to meet its short term investment needs. These cash products are extremely liquid with low volatility and are quoted on a yield basis which is the interest rate on the deposit. Macquarie bank’s Andrew Rock (2009) recommends that cash should be the hub of all investment portfolios for a wealth creator which is what Vision Finance is aiming to achieve for BHC (The Decision Makers – Interest Rates and Cash Opportunities 2009). Given the volatility of the market post GFC and while the European debt crisis looms it is a must to have the correct weighting in risk-free products such as cash. There is a vast range of cash products available in Australia’s saturated financial market which can be tailored to suit the needs of any risk profile. The balance of cash in BHC’s investment portfolio should also be altered when systematic risk varies due to these economic factors. For example the European debt crisis worsening would result in increased systematic risk and hence BHC’s cash weighting should also increase as a defensive measure (The Decision Makers – Interest Rates and Cash Opportunities 2009). Overnight and 7-day cash products can be utilised to take advantage of the short term fluctuations.
Term deposits are more stable form of cash product used in the investment strategy that is recommended for BHC. Often companies have a short memory of the losses incurred during the GFC, especially in times of renewed prosperity when there are large gains being made. However as indicated in the market view, economic conditions are uncertain which necessitates the use of low risk – low return products. These stable money market products provide greater security to an investment portfolio (The Decision Makers - Term Deposits 2009). Fixed term deposits are an effective way for BHC to lock in their returns for a 6 month period given the forecast of falls in interest rates over this period. This will avoid renegotiation of the investment agreement in a market with a falling interest rate. Previously mentioned are the risk-free and low-risk money market products. There are however higher risk and higher return short term investments available to companies such as BHC. Discount Securities are often referred to as enhanced cash products as they offer a higher risk higher return trade off. These investments offer the opportunity for a company such as BHC to apply rigorous testing to a potential investment and weigh up the risk and return available (Halligan 2009). BHC should consider investing in commercial bills as a discounter as they offer a fixed return for their investment at the maturity date. This would allow BHC to lock in the return on their investment which would be advantageous given the forecast falling interest rates. The bills may be bank accepted which offers greater creditworthiness however if analysed correctly BHC may wish to invest in some non-bank bills as a slightly speculatory option that offer a greater return. These bills range from 7 to 185 days which matches BHC’s 6 month investment time frame. Promissory notes, treasury notes and certificates of deposit are the other money market options open to BHC. These products vary in risk however Vision recommends the least volatile options invested in highly credible companies, the government and banks, which may be used to diversify BHC’s investment portfolio. (Halligan 2009) Given the current volatility in the Australian economy longer term investments are high risk, depending on their liquidity, at the present time however it is advised that BHC consider the options available and depending on their characteristics invest a proportion of the available funds in this market. The debt capital market covers longer term investments of greater than 12 months. The main debt instrument utilised in this market is the fixed interest bond from both government and corporations. This type of investment would offer BHC a fixed return on their investment through ongoing coupon payments and would actually increase in value with a fall in interest rates. Therefore if the forecast fall in interest rates eventuates BHC would have the opportunity to sell the bond at a premium in the liquid secondary market. This would give BHC a two-fold return allowing the company to receive the coupon payments for as long as management desires then given the advice of future interest rate movements they can take advantage of a sale of the bond at a premium to the purchase price (Oakley 2008).
As identified throughout the report Vision finance recommends a diversified investment portfolio aimed at using the matching principle to align the maturity of investments with BHC’s investment timeframe. Therefore this investment portfolio would be more heavily weighted to towards short term money market investments such as cash products and commercial bills. These products are reasonably low risk and less volatile and will protect BHC against a market that is currently quite volatile and difficult to predict due to current economic events previously identified. It id recommended however that BHC also invest in a portion of longer term debt capital market products such as Australian bonds. This would act as a slightly speculative portion of investment and is aimed at taking advantage of the forecast interest rate movements. It relies on the liquidity of the secondary market to give BHC an opportunity for capital gain and an exit strategy.

3. Conclusion
In concluding, BHC must consider all the economic factors, interest rate forecasts and current economic events outlined throughout this report when selecting an optimal investment strategy in the Australian money and debt capital markets. Senior management should consider all expert opinions featured and the advice given by Vision Finance to minimise volatility and maximise returns on the AUD$350m BHC will receive in the coming weeks. Vision Finance has identified various Australian short term money market products and longer term debt capital market products available which match BHC’s investment timeframe and risk profile.

List of References • Kaufman, H, 2011, ‘What does the yield curve tell us?’, The Investment Dealers’ Digest, March, vol. 77, no. 11, pp. • Stevens, G, Reserve Bank of Australia, 2011, Governor: Monetary Policy Decision, Media Release, no. 2011-34, Australia • Glynn, J, 2011, ‘RBA open to more rate cuts; revises inflation, growth cuts’, The Australian, 4 November, p.1 Business section. • Colebatch, T, 2011, ‘Good news for bad reason: interest rates tipped to fall’, The Age, July 16, p. 2 Business section • Shamim, A, 2011, ‘Australia has room to move on monetary and fiscal policy, treasurer says’, Bloomberg, November 11, viewed 12 November 2011 • Halligan, P, 2009, ‘In depth technical view – the safe way to invest in cash’, Pensions week, August • Australian Government Bond Yield Curve 2011, Fureyous, viewed 8 November 2011, http://www.michaeljfurey.com/2011/10/07/australian-government-bond-yield-curve-not-much-change • Oakley, D, 2008, ‘Issuers turn to local currency debt’, Markets & Investing, May, p.25 • The Decision Makers - Term Deposits, 2009, Television program, FSiTV, 7 September, http://www.fsitv.com/pages/sub_program/119 • The Decision Makers – Interest Rates and Cash Opportunities, 2009, Television program, FSiTV, 30 November, http://www.fsitv.com/pages/sub_program/128

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