Risks on vietnam stock market

ACADEMY OF BANKINGEVALUATING THE RISKS ASSOCICATED WITH INVESTING IN THE VIETNAMESE SECURITIES MARKET Dao Manh Cuong Student code : 14A7510029 Abstract : The development of Vietnam sto

ACADEMY OF BANKING

EVALUATING THE RISKS ASSOCICATED WITH INVESTING IN THE VIETNAMESE

SECURITIES MARKET

Dao Manh Cuong

Student code : 14A7510029

Abstract :

The development of Vietnam stock market (VSM) comes along a lot of risk This essay will illustare some types of risk on VSM and proposed solutions to hedge them I hope that this study will be helpful in understanding the subject.

Keywords : systematic, unsystematic, market risk, interest rate risk, exchange

rate, risk, inflation risk, legislative risk, business risk, liquidity risk, asymmetric information, managementảisk, profitability, methods, portfolio, derivatives

2908 in 2000 to nearly 1.2 million in 2011, among which, around 16 000

accounts are foreign investors and institutions The stock market has also

contributed considerably to the development of Vietnam with its market

capitalization accounting for 42% of GDP in 2010 as illustrated in Table 1

However, the market size is still small compared with other regional markets, implying enormous potential for growth

Table 1 presents the statistical information about the Vietnamese stock Mcap is market capitalization in billion VND; Accounts are the number of

investors’ accounts investing in the Vietnamese stock market; %GDP is the

percentage of Vietnam stock market in GDP; Listed co is number of listed

companies each year.

Vietnamese stock market, although still characterized by low

capitalization, is one of the world’s rapidly.Vietnam, along with China, India, Indonesia, Thailand, Philippines and Malaysia will outpace the rest of the world over the next two years, the International Monetary Fund said in an April report Inevitably, along with development, risk is one of the most worrying problems

facing Vietnam today Moreover, Vietnamese securities market is one of the few capital markets under the management of a communist government Thus, there are many different ways of managing financial markets and politics leading to specific types of risk in Vietnam.

II. Risk and Market Risk Premium

1. What is risk?

The chance that an investment 's actual return will be different than

expected Risk includes the possibility of losing some or all of the original

investment Different versions of risk are usually measured by calculating

the standard deviation of the historical returns or average returns of a specific investment A high standard deviation indicates a high degree of risk.

Risk in stocks investment is the possibility of occuring the unexpected investing result, or more specifically, is the probability of getting the different future real profit from the initially expected profitability.

Therefore, all factors changing the originally hoped profitability are considered risks.

2. Market Risk Premium - offsetting of risks.

Risk is an important component in assessment of the prospects of an

investment Most investors while making an investment consider less risk as favorable The lesser the investment risk, more lucrative is the investment

However, the thumb rule is the higher the risk, the better the return The spread between the average profitability of risky assets and riskless asset is called

“Market Risk Premium” (MRP).

Assuming the statistical average annual profitability for the period (t) of a some securities on the Vietnamese stock market are as follows:

Securities Average profitability

III. Classification of risk on Vietnam securities

market (VSM)

There are many types of risk making the profitability in investment

different from the expectations of investors However, in securities investment,

we could classified risk into systematic risk and unsystematic risk.

Systematic risk, also known as “undiversifiable risk,” or “volatility”, affects the overall market, not just a particular stock or industry This type of risk is both unpredictable and impossible to completely avoid It cannot be mitigated through diversification, only through hedging or by using the right asset

allocation strategy.

Unsystematic risk, also known as “nonsystematic risk,” "specific risk,"

"diversifiable risk" or "residual risk," is the risk of price change due to the unique circumstances of a specific security, as opposed to the overall market This risk can be virtually eliminated from a portfolio through diversification By owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors

will be less affected by an event or decision that has a strong impact on one company, industry or investment type.

We will look at those types of risk on Vietnamese securities market.

1. Systematic risk

a. Market risk.

Stocks price can fluctuate significantly in a short time , even though the company's income do not change There are many different cause for this, however, it mainly depends on the investors’ perception for stocks in general , or for a particular group of stocks The changes in profitability of most stocks, which is mainly due to the conversion of investors’ expectation, is called market risk

Market risk occurs because of the reaction of investors to the tangible events such as the economic, political , social cases or intangible events or intangible events that arise by dint of the psychological factors of market.

In Vietnam , a typical example is the case when the European debt crisis began breaking out in 2010 From July to August 2010 , two Vietnam stocks indexes hit the lowest point of the year In two months , VN - Index dropped by more than 16% In 2011, moreover, VN-Index bottomed five consecutive times.

Mr Le Ba Hoang Quang , the expert of Sacombank said that : “The direct impacts of the European debt crisis on VSM were not really marked The

variation that we have seen in recent sessions were as a result of the

psychological factors and outrageous reactions."

In addition, Vietnamese investors are still heavily influenced by “herd

mentality” They are excitable by the market , sold at low prices and buy at high prices, leading to the high risks

b. Interest rate risk

In theory, the interest rates and the stock sprice have a negative

correlation because of some following reasons :

Firstly, lower interest rate will make the savings channel become less attractive, therefore cash flow turns to other channels to find the higher

incomes.

Next, a rise in the interest rate reduces the present value of future

dividend’s income, which should depress stocks prices

Conversely, low interest rates result in a lower opportunity cost of

borrowing Lower interest rates stimulate investments and economic activities, which would cause prices to rise.

VSM has seen many

other cases following this

rule Recently, from 10 -

immediately after the

State Bank decided to

reduce the interest rate

ceiling.

However, because of the natures of a nascent market, in many cases, the lower interest rates did not make positive effects on the VSM For

example, in June 2012, after being successful in stimulating the stock market in the last two months, the reductions in interest rate lead to a fall by 1.76% of VN-Index and 2, 31% of HNX- Index Trading value on HSX only was around 700 billion/day, and almost $ 300 billion/day on HNX This is because many stock companies and

investors simultaneously think that VSM was not strong enough to establish a upward trend and the expected return was not commensurate with risk Brokers

also advised the investors to limit their disbursement during this period

This leads to the very low liquidity on VSM.

In addition, in the context of banking reform, the change of interest rate

will be very difficult to predict, thereby it creats the unforeseen modifications on

VSM Interest rate impacts on price on the whole market and because

individuals and organizations are not able to decide the interest rate, so it is

almost impossible to avoid this kind of risk Therefore, interest rate risk is

considered to be a systematic risk.

c. Exchange rate risk

Exchange-rate risk is the risk that investors face when they buy and hold

investments in a currency other than their native currency Currency prices

fluctuate up and down just as shares do If the currency in which the investment

is held gains value compared to the investor’s native currency, the investment

will be worth more to the investor However, if the currency in which the

investment is held loses value compared to the investor’s native currency, the

investment will be worth less to the investor Exchange-rate risk can even offset

any gains the investment may have made on its own

The Vietnam Dong (VND) exchange rate is unstable For instance, in 2011, the VND slumped to as weak as 20,893 per dollar, compared with 19,498 only in one day, the most devaluation since at least 1993 It seems to be risky for both investors and firms.

 For investors , exchange rate is mainly concerned about by

institutional or foreign investors In theory, the exchange rate risk is due to the impact of exchange rates on the investments When

investors think that the currency may devaluated in the future, they will decide not to invest in that country’s market because of the

reduction in securities value When investors invest in the Vietnamese market , however, they are forced to use VND Meanwhile , the VND exchange rate against other major currencies , such as USD/VND , EUR/VND , JYP /VND often tend to decrease Therefore, if foreign

investors really appreciate the potential of VSM, they will still fund foreign currency to convert to VND The problem is that when the liquidity and dividends are swollen, the profitability of securities

investments will not be enough to offset the devaluation of the

exchange Hence, the effects of exchange rate risk on investors is not marked.

 For firms, according to an official from the State Bank of Vietnam, the strong exchange rate change policy may lead to unforeseeable risks Many Vietnamese enterprises borrowed USD from domestic and

international banks If their main incomes are in VND and they have to settle debts in USD, their profits will reduce in the event of higher USD/VND exchange rate Even, some may be unable to settle debts; therefore, this greatly affect on the liquidity of that company’s stock In fact, many companies reported in their financial statements in 2008

that their business results were seriously affected by the exchange rate risks.

The typical example of foreign exchange risk is Pha Lai Power Joint Stock Company The power generator borrowed in Japanese yen It had

to incur double exchange rate risks: one is the depreciation of VND against USD and the appreciation of yen against USD At that time, the shares in Pha Lai Power Joint Stock Company were put under special surveillance of market authorities because they suffered losses in 2008.

d. Inflation risk.

Inflation risk is also known as Purchasing Power Risk, this risk arises from the decline in value of securities cash flow due to inflation, which is measured

in terms of purchasing power.

The research shows that in all five-year periods between 1991 and 2012, Vietnam outpaced all other regional nations in only one aspect: inflation Inflation in Vietnam was over 18% in 2011 and 6.8% in 2012, far higher than the average 3% of China, Indonesia, the Philippines and Thailand

Indonesia had the highest inflation among these nations, 3.8-5% in the last two years, still lower than the rate in Vietnam From 1986 to 2012, there were 13 years and four five-year periods in which inflation in Vietnam stayed

at a double-digit level or above Notably, the average inflation rate in

Vietnam was 225% in the 1986-1992 period, 16.3% in 2007-2008 and 15%

in 2010-2011 In the period from 2008 to 2012, Vietnam recorded an average economic growth of 5.9% per year and inflation of 12.6%, while the

respective figures in China were 9.3% and 3.3%.

Table 4 shows the relationship between the inflation and Vietnam stock

As we can see, 2007 saw the notable improvement of VN-Index when CPI had been controlled Vice versa, from 2008 to 2009,the inflation reached the highest level, making the index fell sharply.

The Price Management Department under the Ministry of Finance has forecast that there still are risks for Vietnam’s inflation to be high in 2014 due to the impact of policies to remove difficulties for business and

production in 2013 According to Dr Vu Dinh Anh, in 2014, prices and market will also be impacted by loosening policies such as the widening of budget deficit to 5.3 percent of GDP and the issuance of bonds worth 170 trillion VND (8 billion USD) for the 2011-2015 period.

Moreover, high inflation is the risk that raise the interest rate (i = ir + π e ) , leads to the stock devaluation, as stated above.

e. Legislative risk.

This risk is inevitable for all new formed stock market The government can issue different types of policies affecting directly to investors This may cause investors can not implement the investing strategies that could have been done Especially, when the policy suddenly changes, investors may be stuck, even be illegal if they can not catch up with the policy change

On 27/9/2010, Circular no 19/2010/TT-NHNN amending Circular no 13/2010/TT-NHNN defining the prudential ratios of credit system was

enacted Circular No 13 and Circular 19 is the legal documents which is considered to be the biggest effect on VSM in 2010 because of the possibility

of massive divestment of banks This could reduce the lending activities for investments in securities, real estate, to ensure the capital adequacy under the new standard.

2. Unsystematic risk.

a. Business risk.

The possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs,

competition, overall economic climate and government regulations A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure that it can meet its financial obligations at all times.

In Vietnam, there are many factors that lead to the busniness

environmental risks of firms, the following can be mentioned:

 Goods and services supply/demand

In 2006, Vietnam joined the WTO; however, goods and services market is seem to be more unstable This has brought many risks for businesses with the adverse shifts in supply and demand of their goods and services.

For example, in 10 months of 2012, Vinacomin produced 36.7 million tons

of coal being equivalent to 34.5 million tons of clean coal

However, on account of the low domestic purchasing power, especially for household electricity, cement, fertilizer, chemicals and building materials , coal consumption was estimated at 30.7 million tons, equals 67.6% of the plan and 84.4% compared to the same period in 2011 This brought on the fact that in 3,000 billion bonds released in July 2012 of this company, the rate on successful bond sale was only 17% of the offered Coupon rate was only 14,5% for the first year.

 Labor force Generally speaking, labor costs in Vietnam are low and competitive in attracting the foreign investment But the negative side is that strikes should happen if wage rates are too low Besides, the quality of labor is a challenge facing Vietnam Due to the weakness of the educational and training system, the economy has been not provided with good skilled labors and managers During the last three decades, Vietnamese government launched many programs to reform the education and training Despite of these efforts, no significant

performances in this area have been recorded The key reason of this failure, from my viewpoint, is the problem of the ideology, which really hinders the

international integration of Vietnam in the field of education and training.

 Taxes and other expenses Vietnam has improved considerably as a site for investment However, it cannot compete fully with either BOI Zone 3 in Thailand or with most areas in China, but it has considerably narrowed the difference and should not be

dismissed outright in any case Land ownership or more accurately land lease as that is all that the Vietnam law currently allows is still significantly less