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 I. Introduction The VSM officially came into operation on 28 July 2000 with only five listed companies during the year. By the end of 2011, the number of listed companies had increased to 705. Market capitalization has grown from less than USD 1 billion to nearly USD 20 billion, with investor accounts rising from 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 oraverage 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 Common stock 14% Corporate bond 7% Government bond 5,5% Treasury bill 4% If we consider treasury bill as a riskless asset (risks equal 0) and other types of securities such as government bond, corporate bond, common stock are risky assets in different degrees. The risk offseting risks of each type of securities will be: Securities Average profitability Common stock 10% Corporate bond 3% Government bond 2,5% In Vietnam, MPR has been very high (13.3% in 2010). However, Vietnam market is still not long enough to assess the stability of yields as well as lack of the representative of market portfolio. 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 - 03/14/2014, VN-Index went up again by 2.95% to 596.83 points, the HNX-Index also increased by 2.76% to 84.43 points, while the VS 100 showed an growth of 3.39% to 99.01 points, 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%. [...]... session reached 2.578 billion, jumped by 31% when compared with 2012, however, mainly by government bond trading (1,257 billion VND/session, surged by 90%) The market maker systems on both the primary market and the secondary market were formed; 36 market members were recognized Therefore, the liquidity in 2014 is considered to be quite satisfactory c Asymmetric information A situation in which one... Research, Faculty of Economics, SHIGA UNIVERSITY - Vietnam pushing stock market with ETFs, future derivatives”, Stockbiz, available at http://en.stockbiz.vn/News/2014/3/27/461600 /vietnam- pushing-stockmarket-with-etfs-future-derivatives.aspx - “Monthly Deposit and Lending rate”, SBV Monthly Reports and Other sources - (indicated if any) “The Vietnam Stock Market Report 03-22-2012”, VietnamReport, available... the low confidence in the government policy on the protection of the property rights, as the consequence of the past policy on the private sector as well as the current policy on “a market economy with socialist orientation” The property rights index is reported by the Heritage Foundation and the Wall Street Journal as a subcomponent of the Index of Economic Freedom In their 2010 Report, Vietnam got... 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... Management on Vietnam Stock Market , Stockbiz, available at http://www.stockbiz.vn/News/2011/11/2/249169/which-standardsfor-risk-management -on- vietnam- stock- market. aspx - Ji Wu (Xiamen University), Cuong Nguyen (Lincoln University) , Andros Gregoriou (University of Hull) , “Systematic Risk, Idiosyncratic Risk, and Asset Pricing Models: Empirical Evidence from the Vietnamese Stock Market - “Investors... legislation and intensified law enforcement • Establishing and improving the supervision of the organization of the securities markets • Improving the listed companies to disclose information systems, and strengthening the supervision of insider • Improving the corporate governance structure of listed companies • Strengthening the supervision of securities intermediaries In conclusion, Vietnam stock market. .. The Vietnam Securities Depository is completing a project that allows clearing of ETF products and deals with risks related to ETF transaction cancellation After all the steps are finished and piloted at stock exchanges, the first ETFs will be launched into transaction 3 Reducing asymmetric information :  • For investors : Getting away from the penny stocks which lack of information because that stocks...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... compared to 90 of Hong Kong, 90 of Singapore and 80 of Japan (the higher scores the more desirable with the range from 0 to 100) In conclusion, bad management and the lack of an efficient mechanism to supervise are leading to the risks of losses and reducing the value of securities in Vietnam The relationship between profitability and IV risk on VSM through some important milestones  Profitability... corporate stocks, stock prices will rise; however, those investors may be selling bonds to fund their stock purchases, causing bond prices to fall Spreading investments between stocks and bonds will protect against the risk of either category performing poorly Whit managing the risk of each trade your portfolio risk will be well under control and you manage your portfolio risk actively, but to control . 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. 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. 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