Making sense of my degree in Finance

10 major points:

1. KLCI dropped 14% in May 2018

2. KLCI was 1,846.51 points on 8 May 2018; fell 11.5% to close at 1,633.55 points a year after (8 May 2019)

3. Overnight Policy Rate was cut by 25 basis point because of increased risks to economic growth

4. Various mega projects on hold especially construction and property

5. Foreign investors dumped $500 million worth of shares up til Apr 15, 2019

6. Budget deficit pushed to five-year high of 3.7% GDP in 2018

7. After slashing GST, Malaysia is more reliant on oil-related and non-tax revenues (although new taxes will be introduced to plug the deficit hole)

8. Although oil prices have recovered, Malaysia imports more than exports oil products

9. Mahathir to better his relationship with China

10. Central Bank cuts it benchmark interest rate for the first time since July 2016 to improve economy

What is investment? - Real Assets and Financial Assets

Productive capacity of a society’s economy i.e. the goods and services its members can create will determine the wealth of a society. Whilst some members may own plantations and factories, others may just be earning salaries by working for firms.

Imagine the following scenario:

The rich families in a society possess the land, buildings, machines and knowledge (as they can afford better education). These are called real assets and they can be used to generate income by producing goods and services.

As the economy gets developed and the people get wealthier, the rich families would want to expand their businesses. Some may use their own money but some may prefer to take out loans.

Loans from banks or financial institutions usually come with relatively high interest. Well, they can borrow from families and friends but it would still be a loan. What other options do they have besides loans?

If the firms have good track records (consistently profitable) and good business plans, they can appeal to individual investors (or institutional investors) to buy their shares.

Loans, bonds and shares are examples of financial assets. Through these, individuals can hold a claim to the real assets, or income generated by the real assets.

In other words, while real assets generate income to the economy, financial assets define the allocation of income of the real assets or wealth, among investors.

Financial assets may be an asset to individuals/households, but they are considered a liability to the firms. When person A buys equity shares from firm B, firm B will use that money to buy real assets. When income is generated, person A will have a claim on a portion of the profit earned. So now, firm B has to pay person A, which becomes a liability to firm B.

Therefore, we can define financial instruments like shares and bonds, to be any contract that gives rise to a financial asset of an entity, while giving rise to a financial liability (or equity) of another entity.

References:

Book: Bodie, Kane and Marcus. Investments, 10th Ed, 2014.