ACKNOWLEDEGEMENT

First of all we are really thankful to our Lord who gave us enough courage and strength to

complete this research prosperously.

I owe deep appreciation to

MR Muhammad Sajid who is a sincere, cooperative and hardworking teacher and under whose

capable supervision we did our fieldwork. His constant guidance and academic discussions

helped us a lot in collecting information.

INTRODUCTION

As per definition Portfolio means “a collection of securities owned by an investor”. It represents

the total holdings of securities belonging to any person". It comprises of different types of assets

and securities.

In finance, a portfolio is an appropriate mix or collection of investments held by an institution or

an individual.

Holding a portfolio is a part of an investment and risk-limiting strategy called diversification. By

owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets

in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate,

futures contracts, production facilities, or any other item that is expected to retain its value.

In building up an investment portfolio a financial institution will typically conduct its own

investment analysis, whilst a private individual may make use of the services of a financial

advisor or a financial institution which offers portfolio management services.

Portfolio Management

Portfolio management refers to the management or administration of a portfolio of securities to

protect and enhance the value of the underlying investment. It is the management of various

securities (shares, bonds etc) and other assets (e.g. real estate), to meet specified investment

goals for the benefit of the investors. It helps to reduce risk without sacrificing returns. It

involves a proper investment decision with regards to what to buy and sell. It involves proper

money management. It is also known as Investment Management

Portfolio management involves deciding what assets to include in the portfolio, given the goals

of the portfolio owner and changing economic conditions. Selection involves deciding what

assets to purchase, how many to purchase, when to purchase them, and what assets to divest.

These decisions always involve some sort of performance measurement, most typically expected

return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the

return). Typically the expected return from portfolios of different asset bundles is compared.

The unique goals and circumstances of the investor must also be considered. Some investors are

more risk averse than others. Mutual have developed particular techniques to optimize their

portfolio holdings. The art and science of making decisions about investment mix and policy,

matching investments to objectives, asset allocation for individuals and institutions.

Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice

of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs

encountered in the attempt to maximize return at a given appetite for risk.

Portfolio management involves maintaining a proper combination of securities which comprise

the investor’s portfolio in a manner that they give maximum return with minimum risk. This

requires framing of proper investment policy. Investment policy means formation of guidelines

for allocation of available funds among the various types of securities including variation in such

proportion under changing environment. This requires proper mix between different securities in

a manner that it can maximize the return with minimum risk to the investor. Broadly speaking

investors are those individuals who save money and invest in the market in order to get return

over it. They are not much educated, expert and they do not have time to carry out detailed study.

They have their business life, family life as well as social life and the time left out is very much

limited to study for investment purpose. On the other hand institutional investors are companies,

mutual funds, banks and insurance company who have surplus fund which needs to be invested

profitably. These investors have time and resources to carry out detailed research for the purpose

of investing.

DEFINATION

PORTFOLIO:

As per definition Portfolio means “a collection of securities owned by an investor”. It represents

the total holdings of securities belonging to any person".

PORTFOLIO MANAGEMENT:

“The process of managing the assets of a mutual fund, including choosing and monitoring

appropriate investments and allocating funds accordingly.”

What is Investment?

An investment is the current commitment for a period of time in order to derive future payments

that will compensate the investor for

(1) The time the funds are committed

(2) The expected rate of inflation during this time period

(3) The uncertainty of the future payments

The “investor” can be an individual, a government, a pension fund, or a corporation. Similarly,

this definition includes all types of investments, including investments by corporations in plant

and equipment and investments by individuals in stocks, bonds, commodities, or real estate. This

text emphasizes investments by individual investors.

Different Types of Investment:

Real Interest Rate

Inflation Premium

Risk Premium

Real Interest Rate:

An interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of

funds to the borrower, and the real yield to the lender. The real interest rate of an investment is

calculated as the amount by which the nominal interest rate is higher than the inflation rate.

Real Interest Rate = Nominal Interest Rate - Inflation (Expected or Actual)

Inflation premium:

The higher return that investors demand in exchange for investing in a longterm security where infla

tion has a greater potential to reduce the real return.

The portion of an investment returns that compensates for expected increases in the general price 

level of goods and services. Theexpectation of rising inflation results in higher longterm interest 

rates as lenders and borrowers build in an increased inflation premium. Letting r denote the real

interest rate, i denote the nominal interest rate, and let π denote the inflation rate, the Fisher

equation is: i = r + π. In the Fisher equation, π is the inflation premium.

Risk Premium:

A risk premium is one way to measure the risk you'd take in buying a specific investment.

The additional return an investor expects from holding a risky asset rather than a riskless one, in

essence the difference between the total expected return on an investment and the appropriate

estimated risk-free return.

Risk Premium = Expected return - risk free rate

INVESTMENTOBSTACLES:

When creating a policy statement, it is important to consider an investor's constraints. There are

five types of constraints that need to be considered when creating a policy statement. They are as

follows:

1. Liquidity Constraints: 

Liquidity constraints identify an investor's need for liquidity, or cash. For example, within the

next year, an investor needs Rs50, 000 for the purchase of a new home. The Rs50, 000 would be

considered a liquidity constraint because it needs to be set aside (be liquid).

2. Time Horizon:

A time horizon constraint develops a timeline of an investor's various financial needs. The time

horizon also affects an investor's ability to accept risk. If an investor has a long time horizon, the

investor may have a greater ability to accept risk because he would have a longer time period to

recoup any losses. This is unlike an investor with a shorter time horizon whose ability to accept

risk may be lower because he would not have the ability to recoup any losses.

3. Tax Concerns: 

 After-tax returns are the returns investors are focused on when creating an investment portfolio.

If an investor is currently in a high tax bracket as a result of his income, it may be important to

focus on investments that would not make the investor's situation worse, like investing more

heavily in tax-deferred investments.

4. Legal and Regulatory:

 Legal and regulatory factors can act as an investment constraint and must be considered. An

example of this would occur in a trust. A trust could require that no more than 10% of the trust

be distributed each year. Legal and regulatory constraints such as this one often can't be changed

and must not be overlooked.

5. Unique Circumstances:

  Any special needs or constraints not recognized in any of the constraints listed above would fall

in this category. An example of a unique circumstance would be the constraint an investor might

place on investing in any company that is not socially responsible, such as a tobacco company.

INVESTMENT DECISION:

Determination of where, when, how, and how much capital to spend and/or debt to acquire in the

pursuit of making a profit. An investment decision is often reached between an investor and

his/her investment advisors. Depending on the type of brokerage account an investor has,

investment managers may or may not have tremendous leeway in making decisions without

consulting the investor himself/herself. Factors contributing to an investment decision include,

but are not limited to: capital on hand, projects or opportunities available, general market

conditions, and a specific investment strategy.

Component of investment decision:

Return:

Return is basically outcome of investment. Every individual investor make investment with aim

of getting some return. Two types of return:

1. Expected return:

The expected return (or expected gain) refers to the value of a random variable one could

expect if the process of finding the random variable could be repeated an infinite number of

times. Formally, it gives the measure of the center of the distribution of the variable.

2. Realized Yield:

The actual amount of return earned on a security investment over a period of time. This period

of time is typically the holding period which may differ from the expected yield at maturity.

Risk:

Investment risk can be defined as the probability or likelihood of occurrence of losses relative to the

expected return on any particular investment. Description: Stating simply, it is a measure of the level of

uncertainty of achieving the returns as per the expectations of the investor

Investment in Pakistan:

Growth and Investment:

Global economic growth during the outgoing year has witnessed some continuing signs of

improvement with a pick-up in high-income economies along with some improvement in

developing countries.

China and Pakistan have made agreements to establish China Pakistan Economic Corridor

between the two countries. The corridor will serve as a driver for connectivity, trade in the world

is expected to increase and Pakistan will take benefits through multiple dimensions.

Major trading partners of Pakistan are growing with better outlook, which will certainly have

positive impact on the economy of Pakistan and provides an opportunity to uplift socio-economic

condition of common man in the country.

Pakistan is improving quantitatively and qualitatively as growth achieved 4.24 percent is broad

based and is the highest achievement since 2008-09.

Major success of the outgoing fiscal year includes: picking up economic growth, inflation

contained at lowest level since 2003, improvement in tax collection, reduction in fiscal deficit,

worker remittances touches new height, successful launching of Sukuk, foreign exchange

reserves significantly increased and stock market created new history.

The GDP growth accelerates to 4.24 percent in 2014-15 against the growth of 4.03 percent

recorded in the same period last year. The growth momentum is broad based, as all sectors

Namely agriculture, industry and services have supported economic growth.

The agriculture sector accounts for 20.9 percent of GDP and 43.5 percent of employment, the

sector has strong backward and forward linkages. The agriculture sector has four sub-sectors

including: crops, livestock, fisheries and forestry.

The industrial sector contributes 20.30 percent in GDP; it is also a major source of tax revenues

for the government and also contributes significantly in the provision of job opportunities to the

labor force.

Industrial sector continued growth process and recorded growth at 3.62 percent as compared to

4.45 percent last year.

The manufacturing is the most important sub-sector of the industrial sector comprising 65.4

percent share in the overall industrial sector. Growth of manufacturing is registered at 3.17

percent compared to the growth of 4.46 percent last year.

Manufacturing has three sub-components; namely the Large-Scale Manufacturing (LSM) with

the share of 80 percent, Small Scale Manufacturing with the share of 13 percent and Slaughtering

with the share of 7 percent.

Small scale manufacturing witnessed growth at 8.24 percent against the growth of 8.29 percent

last year and slaughtering growth is recorded at 3.32 percent as compared to 3.40 percent last

year.

LSM has registered the growth of 2.38 percent as compared to the growth of 3.99 percent last

year.

The share of construction in industrial sector is 12 percent and is one of the potential components

of industries. The construction sector has registered a growth of 7.05 percent against the growth

of 7.25 percent of last year.

Sector witnessed a growth of 3.84 percent as compared to 1.65 percent growth of last year.

Electricity generation & distribution and Gas Distribution is the most essential component of

industrial sector. This sub-sector has registered growth at 1.94 percent as compared to 5.57

percent in last year.

The share of the services sector has reached to 58.8 percent in 2014-15. Services sector contains

six sub-sectors including: Transport, Storage and Communication; Wholesale and Retail Trade;

Finance and Insurance; Housing Services (Ownership of Dwellings); General Government

Services (Public Administration and Defense); and Other Private Services (Social Services).

The Services sector has witnessed a growth rate of 4.95 percent as compared to 4.37 percent last

year. The growth performance in services sector is broad based, all components contributed

positively in growth, Finance and Insurance at 6.1 percent, General Government Services at 9.4

percent, Housing Services at 4.0 percent, Other Private Services at 5.9 percent, Transport, Storage

and Communication at 4.2 percent and Wholesale and Retail Trade at 3.4 percent.

Three main drivers of economic growth are consumption, investment and export. Pakistani

society like other developing countries is a consumption oriented society, having high marginal

propensity to consume.

The private consumption expenditure in nominal terms reached to 79.20 percent of GDP, whereas

public consumption expenditures are 11.84 percent of GDP. Total consumption expenditures

have reached to 91.04 percent of GDP in outgoing fiscal year compared to 91.46 percent of last

fiscal year.

Per capita income in dollar terms recorded a significant growth of 9.25 percent in 2014-15 as

compared to 3.83 percent last year. The per capita income in dollar terms has reached to $1,512 in

2014-15.

Total investment is recorded at 15.12 percent of GDP, Fix investment is registered at 13.52

percent of GDP. Private investment witnessed at 9.66 percent of GDP. Investment has been hard

hit by internal and external factors during the last few years but now situation is improving.

Total investment witnessed a growth of 10.21 percent as compared to 8.4 percent last year. Public

investment recorded an impressive growth rate at 25.56 percent as compared to 6.82 percent last

year.

Total investment which was recorded at Rs.3756 billion in 2013-14 increased to Rs.4140 billion

for 2014-15.

Public investment which was recorded at Rs.842 billion in 2013-14 is reported at Rs.1057 billion

in 2014-15.

Public investment as a percent of GDP increased to 3.86 percent against the 3.36 percent last

year.

During July-March, 2014-15 credit to private sector flows increased to Rs.228.2 billion against

the expansion of Rs.305 billion in the comparable period last year.

National savings are 14.5 percent of GDP in 2014-15 compared to 13.7 percent in 2013-14.

Domestic savings is witnessed at 8.4 percent of GDP in 2014-15 as compared to 8 percent of

GDP in 2013-14. Net foreign resource inflows are financing the saving investment gap.

Present government has launched comprehensive plan to create investment friendly environment

and to attract foreign investors in the country. As is evident, the capital market has reached to

new height and emitting positive signals for restoring the investor’s confidence.

Pakistan's policy trends have been consistent, with liberalization, de-regulation, privatization, and

facilitation being its foremost cornerstones. Board of Investment (BOI) under the Prime

Minister’s office has approved investment policy to provide more investment friendly

environment to investors.

Foreign private investment has reached to $1666.2 million during July-April 2015 as compared to

$1050.3 million showing 58.6 percent higher as compared to last year. Out of total foreign

investment, the FDI inflow has reached to $2057.3 million.

The major inflow of FDI is from US, Hong Kong, UK, Switzerland and UAE. Oil & gas

exploration, financial business, power, communications and Chemicals remained major

recipients.

The government is also aiming to explore new markets to export its manpower as well as

incentives for the remittances to further enhance its growth. The available data suggest inflow of

the remittances for the period of July-April 2014-15 stood at $ 14969.66 million compared to $

12897.91 million during the corresponding period last year, which is 16.06 percent higher over

the previous period.

INVESTMENT ALTERNATIVES: Assets:

Assets are things that people own. The two kinds of assets are financial assets and real assets. The

distinction between these terms is easiest to see from an accounting view point. A financial asset

carries a corresponding liability somewhere. If an investor buys shares of stock, they are an asset to

the investor but show up on the right side of the corporation’s balance sheet. A financial asset,

therefore, is on the left-hand side of the owner’s balance sheet and the right-hand side of the issuer’s

balance sheet. A real asset does not have a corresponding liability associated with it, although one

might be created to finance the real asset.

Financial assets have a corresponding liability but real assets do not.

Securities:

A security is a legal document that shows an ownership interest. Securities have historically been

associated with financial assets such as stocks and bonds, but in recent years have also been used

with real assets. Securitization is the process of converting an asset or collection of assets into a

more marketable forum.

Security Types:

Securities are placed in one of three categories: equity securities, fixed income securities, or

derivative assets.

1) Equity Securities:The most important equity security is common stock. Stock represents ownership interest in a

corporation. Equity securities may pay dividends from the company’s earnings, although the

company has no legal obligation to do so. Most companies do pay dividends, and most companies try

to increase these dividends on a regular basis.

2) Fixed Income Securities:A fixed income security usually provides a known cash flow with no growth in the income stream.

Bonds are the most important fixed income securities. A bond is a legal obligation to repay a loan’s

principal and interest, but carries no obligation to pay more than this. Interest is the cost of borrowing

money. Although accountants classify preferred stock as an equity security, the investment

characteristics of preferred stock are more like those of a fixed income security. Most preferred

stocks pay a fixed annual dividend that does not change overtime consequently. An investment

manager will usually lump preferred shares with bonds rather than with common stocks. Conversely,

a convertible bond is a debt security paying a fixed interest rate. It has the added feature of being

convertible into shares of common stocks by the bond holders. If the terms of the conversion feature

are not particularly attractive at a given moment, the bonds behave like a bond and are classified as

fixed income securities. On the other hand, rising stock prices make the bond act more like the

underlying stock, in which case the bond might be classified as an equity security. The point is that

one cannot generalize and group all stock issues as equity securities and all bonds as fixed income

securities. Their investment characteristics determine how they are treated.

For investment purposes, preferred stock is considered a fixed income security.

3) Derivative Assets:Derivative assets have received a great deal of attention in the 1990s. A derivative asset is probably

impossible to define universally. In general, the value of such an asset derives from the value of some

other asset or the relationship between several other assets. Future and options contracts are the most

familiar derivative assets. These building blocks of risk management programs are used by all large

investment houses and commercial banks.

The three broad categories of securities are equities, fixed income securities, and derivative

asset.

FINANCIAL MARKETS IN PAKISTAN

Financial markets include all markets where transactions relating to the trading of financial

securities and extending credit take place. The following sections provide an overview of

financial markets in Pakistan by highlighting the Pakistan capital market i.e. equity and debt

market characteristics. It also explains the state of affairs of nonperforming loans in Pakistan, its

impact on the overall economic activities.

MONEY MARKETS

1. Money market purpose and structure:

The purpose of money markets is facilitate the transfer of short-term funds from agents with

excess funds (corporations, financial institutions, individuals, government) to those market

participants who lack funds for short-term needs. They play central role in the country’s financial

system, by influencing it through the country’s monetary authority. For financial institutions and

to some extent to other non-financial company’s money markets allow for executing such

functions as:

Fund raising;

Cash management;

Risk management;

Speculation or position financing;

Signaling;

providing access to information on prices

Money markets are wholesale markets with very large amounts of transactions, e.g. with

transactions from 500 million Euro to 1 billion Euro or even larger ones. This is the most active

financial market in terms of volumes of trading. From the start of emergence the traditional

money markets performed the role of monetary policy. In order to influence the supply side,

governments have employed methods of direct regulation and control of the savings and

investment behavior of individuals and companies. However due to fast technological advances

Internationalization and liberalization of financial markets, possibilities to carry out policy

objectives through such measures have diminished. Current policy through market oriented

measures is aimed primarily at demand side. Thus money markets serve the interface between

execution of monetary policy and the national economies another role of domestic money

markets is to serve public policy objectives, i.e. financing public sector deficits and managing the

accumulated government deficits. Government public debt policy is an important determinant of

the money markets operations, since government debt typically forms a key part of the country’s

money markets (as well as debt markets). The scope and measures of monetary policy are also

linked to the government’s budget and fiscal policies. Thus the country’s money market shifts

are depend ant upon the goals of national public policy and tools used to reach these Goals.

Changes in the role and structure of money markets were also influenced by financial

deregulation, which evolved as a result of recognition that excessive controls are not compatible

with efficient resource allocation, with solid and balanced growth of economies. Money markets

went through passive adaptation as well as through active influence from the side of

governments and monetary authorities. Finally, money markets were influenced by such

international dimensions as increasing capital mobility, changing exchange rate arrangements,

diminishing monetary policy autonomy. The shifts in European domestic money markets were

made by the European integration process, emergence and development of European monetary

union.

Money market segments:

Money market: consists of the market for short-term funds, usually with maturity up to

one year. It can be divided into several major segments:

Interbank market: where banks and non-deposit financial institutions settle contracts

with each other and with central bank, involving temporary liquidity surpluses and

deficits.

Primary market: This is absorbing the issues and enabling borrowers to raise new

funds.

Secondary market: for different short-term securities, this redistributes the ownership

measure’s liquidity and as a result increases the supply of lending and reduces its price.

Derivatives market: market for financial contracts whose values are derived from the

underlying money market instruments.

Interbank market: is defined mainly in terms of participants, while other markets are

defined in terms of instruments issued and traded. Therefore there is a considerable

overlap between these segments. Interbank market is referred mainly as the market for

very short deposits and loans, e.g. overnight or up to two weeks. Nearly all types of

money market instruments can be traded in interbank market

.

2. Money market instruments:

Treasury bills and other short-term government securities (up to one year)

Repurchase agreements and similar collateralized short-term loans;

Commercial papers, issued by non-deposit entities (non-finance companies, finance

companies, local government, etc.

Certificates of deposit.

Eurocurrency instruments;

3. characteristics of money market instruments:

short-term nature;

low risk;

high liquidity (in general);

Close to money.

Money markets consist of tradable instruments as well as non-tradable instruments.

Traditional money markets instruments, which included mostly dealing of market participants

with central bank, have decreased their importance during the recent period, followed by an

increasing trend to finance short-term needs by issuing new types of securities such as REPOs,

commercial papers or certificates of deposit. The arguments behind the trend are the following:

An observed steady shift to off-balance sheet instruments, as a reaction to introduction of capital

risk management rules for internationally operating banks in the recommendations of Basel II

Accord and EU Directives on banking.

Advantages provided to high-rated market participants, allowing diversifying borrowing

sources, to cut the costs, to reduce the borrowers’ dependence on banking sector lending and its

limitations.

In terms of risk two specific money-market segments are:

unsecured debt instruments markets (e.g. deposits with various maturities, ranging from

overnight to one year);

Secured debt instruments markets (e.g. REPOs) with maturities also ranging from.

5. Money Market Instrument Use in Pakistan

1. Treasury bills:

“T-bills are the Government debt securities that mature in one year or less from their issue date.

A treasury bill differs from other types of investments in that they do not pay interest in the

traditional way. When an investor wishes to purchase a treasury bill, they buy it at a discount

rate.”

 The Government of Pakistan raise large portion of floating and permanent debt through the

auctions of short term Government of Pakistan Market Treasury Bills (MTBs)

 T-bills are issued through a competitive bidding process rather than paying fixed interest

payments for a price that is less than their face (par) value and when they mature; the

government pays the holder the full par value. Finally, the interest is the difference between the

purchase price of the security and what you get at maturity. T-bills are considered to be the

secure investments, because in these Government confirms the holder of security to pay back

face value. Returns are less because Treasuries are usually safe.

TYPES OF T-BILLS:

 They are issued with the maturities of 

•Three-months (12-Weeks / 90-days)

•Six-months (24-Weeks)

• Twelve-months (one-year)

INVESTMENT CHARACTERISTICS OF TREASURY BILLS:

Default Risk:

T-bills are on the guarantee of government, so they have minimum default risk.

Liquidity:

 T-bills are highly liquid instrument of financial market. Securities can be liquidated

whenever the holder wants.

Minimum Denomination:

T-bills are trade on the face value of Rs.100 in Pakistan and in denominations of multiples of

100.

 HOW T-BILLS ARE TRADED IN PAKISTAN?

“At start, Treasury bills were issued on ‘tap bases’ for six months at 6percent per year.

Afterwards when the government moved to a market-based system as part of the process of

economic deregulation, disinvestment, and decentralization in April 1991 then the following

changes were made:

Introduce the American-style auction-based system.

 The role of primary market restrict to fortnightly auctions, instead of “on tap,” allowing

from the development of a secondary market.

Primary dealers were appointed.

State Bank of Pakistan uses the following two methods to trade T-bills:

Auction System

Open Market Operations(OMO)

PRIMARY DEALERS:

Only primary dealers can participate in the auctions and OMOs

All the commercial banks (having account with SBP)

NBFIs (Non-Banking Financial Institutions)

If the primary dealer wants to buy a T-bill, must submit a bid that is prepared either;

Non-Competitively

Competitively

 The Non-competitive bids are normally submitted by the small investors who agree to accept

the price determined by the auction.

AUCTION SYSTEM:

“SBP is acting as an agent on behalf of the government for raising short term funds from the

market. The MTBs are sold by SBP to approved Primary Dealers through multiple price sealed

bids auction.

The Auction for MTBs is held under a fixed schedule on fortnightly basis.

The actual yield to the investor depends on the accepted bid price at each auction. Each

bidder at an auction gets the amount at his bid price (if accepted), as opposed to a single

price for all the accepted bids.

In the auctions of treasury bills yield is not set by the central bank but the bidder. The auctions

conduct after every two weeks at Wednesday are and announced approximately one week in

advance. Primary dealers, which include commercial banks and non-bank financial institutions,

are only allowed to submit any number of sealed price-quantity bids on their behalf or on behalf

of clients. All auctions were conducted on a discriminatory price basis, so each bid formulate in

the expectation that, if accepted, the price bid would be that paid.

After the deadline for bid submission, the bids open in the presence of the bidders. After the

opening of bids, The Ministry of Finance decides on the cut-off price after seeing the bids; the

highest competitive bidders receives bills and those who bid successively lower price also

receive bills until all available securities have been awarded. Although notionally the size of the

auction issue are pre-announced, in practice the cut-off price seems to have been the main

decision variable and the amount allocated bore little relation to the pre-announced size. 

The setting of the cut-off price was influenced by a number of factors, of which located bore little

relation to the pre-announced size. 

The setting of the cut-off price was influenced by a number of factors, of which

Debt service costs:

o Cost of the factors related to the debt services, e.g. cost for organizing auction etc.

Need for funding:

o Having insufficient funds for regular operations, also influence the cut off price, that

how urgently funds are required

Summary of auction process shown in the figure.

SETTLEMENT OF BID:

“Settlement is normally done through book entry and securities can be issued within one or two days

after finalizing cut-off price. Primary dealers must have to maintain a current account be (for cash

SBP announces the T-Bill auction

Primary dealers submit the bids

After the submission deadline, bids will open

MOF deciedes the cut off price.

After one or two days of finalizing price, securities are issued.

settlement) with the SBP. The positions of primary dealers are maintained by the SBP in these

accounts. The marketable lot-size for MTBs will be in range of PKR 100.0mln - 300.0mln

(multiples of PKR 100.0mln).”

TAX LIABILITY:

“Investors in T-bills are subject to a withholding tax, which is adjusted against their final tax rate,

because the earnings of T-bills are treated as income of the security holder not the capital gain.”

OPEN MARKET OPERATIONS (OMOS):

SBP conducted the first formal open-market operation (OMO) sale of government securities in

1995. Although OMOs were meant to support interest-rate policy, the MOF first used them

only as a borrowing vehicle. In Open Market Operations rather sale of securities Government

can purchase treasuries back to increase the money supply. When money is invested in

treasuries, it is considered to be out of circulation since it is held by the

government.When treasuries are purchased by the government, the investor willprobably then

invest that money in some sort of securities and if the

securities are checking accounts, savings accounts, money market accounts, or CDs, that

increases the money supply to banks allowing banks to loan more money. This also tends to

drive interest rates down both for the depositor as well as the borrower which stimulates the

economy. In OMO Government fix the discount rate before the announcing the new securities

and can be issued when they need funds.

2. COMMERCIAL PAPER:

Commercial paper consists of short-term, unsecured promissory notes issued by well-known

companies that are financially strong and carry high credit rating. Commercial paper is generally

used to meet immediate cash needs.

Funds raised from commercial paper are commonly used for current transactions i.e. to purchase

inventories, pay taxes and cover other short-term obligations rather than for capital transactions

like long-term investments. SBP and SECP started process of creating commercial paper market

in Pakistan in 2003.

MATURITY PERIOD OF COMMERCIAL PAPER:

The commercial paper shall be issued for maturities between 30 days and one year from the date

of subscription. Commercial papers are mainly in the primary market. Opportunities for resale in

secondary markets are very limited.

WHO CAN ISSUE COMMERCIAL PAPER?

Only highly rated companies and financial institutions can issue Commercial Paper, as it

is unsecured and investors can only depend upon the creditworthiness of the issuer.

The equity of the company is not less than Rs. 100 million as per the latest audited

balance sheet and the company maintains a minimum current ratio of 1: 1 and debt/equity

ratio of 60: 40.

The company has obtained the credit rating from a rating agency. The minimum credit

rating of the issuer shall be “A-” (medium to long-term) and “A2” (short-term). At the

time of issue of Commercial Paper Company rating should not be more than two months

old.

The company should have no overdue loan or defaults in the Report obtained from the

Credit Information Bureau (CIB) of the State Bank of Pakistan (SBP).

SIZE AND DENOMINATION:

The minimum size of the issue of commercial paper shall not be less than Rs.10 million. The

commercial paper, in case of private placement, would be denominated in Rs. 100,000 (face

value) or in multiples thereof and in case of offer to general public, may be denominated in Rs.

5,000 or in multiples thereof.

MODE OF ISSUE AND DISCOUNT RATE:

The commercial paper shall be in the form of a promissory note and be issued at such discount to

face value as may be determined by the issuer keeping in view the prevailing T-Bill rates,

KIBOR and its Credit Rating.

CALCULATION OF RATE OF RETURN ON COMMERCIAL PAPER:

Most commercial paper is issued at discount from par and Yield to investor can be calculated by

bank discount method just like treasury bills. Investor’s yield arises from the price of security

between its purchase date and maturity date.

For example; if a million Rs commercial paper with a maturity of 120 days is acquired by an

investor at a discount price of Rs. 950,000.the discount rate of return on commercial paper will

be

DRcp = (Par Value – Purchase Price) / Par Value * 360 / Days to Maturity

DRcp = (1,000,000 – 950,000) / 1,000,000 * 360 /120 = 0.15

so, discount rate of return on this commercial paper will be 15%.

Rate of return on commercial paper fluctuate with the daily ebb and flow of supply and demand

in marketplace.

WHO INVESTS IN COMMERCIAL PAPER?

Commercial paper may be issued by way of Public offer and/or to Scheduled Banks, Financial

Institutions etc. Commonly commercial papers are bought by Money market funds as the issue

size is often too high for individual investors. Generally regarded as a safe investment and not

backed by collaterals

ADVANTAGES FOR INVESTOR:

Due to varying credit standings, investments in commercial papers may bring in higher

yields than time deposits with lower risks.

It is considered to be a safe investment since the financial situation of a company can

easily be predicted over a short period.

3. REPURCHASE AGREEMENT (REPO):

Repurchase agreements are agreements between a borrower and a lender where the borrower, in

effect, sells securities to the lender with the stipulation that the securities will be repurchased on

a specified date and at a specified, higher price. The securities serve as collateral for the loan.

Most Repo agreements mark the collateral to market daily. The value of the collateral drop

below the required margin, then the borrower must send more securities to the lender to maintain

margin or some money to reduce the principal outstanding.

Example: we assume a financial institution has Rs 1 million cash surplus. The borrowing dealer

and lending company agree on 1 million RP loan collateralized by treasury bills, with the dealer

agreeing to buy back the bills within a few days and the interest on loan.

Financial Institution Security Dealer

- Rs. 1 million + Rs 1 million

+ Securities worth 1 million - Securities worth 1 million

After Maturity of Agreement

+ Rs. 1 million - Rs 1million

- Securities worth 1 million + Securities worth 1 million

MAJOR BORROWERS AND LENDERS:

Major borrowers include government bond dealers of Treasuries and federal agency securities,

and large banks. Government securities are the main collateral for most repos, along with federal

agency securities and mortgage-backed securities etc. Active lenders include state and local

governments, insurance companies, non-financial corporations, and foreign financial institutions

who find the market a convenient, relatively low risky way to invest temporary surplus cash that

may be retrieves quickly when the need arises.

CALCULATION OF REPO INTEREST INCOME:

The difference between the underlying securities current price and repurchase price is the

amount of interest paid by the borrower to the lender. Usually the securities pledged behind an

Repo are valued at their current market price plus accrued interest on security less a small

“haircut” (discount) to reduce the lender’s exposure to market risk. Longer the term and riskier

or less liquid the security pledged, larger the “haircut” will be charged.

Interest income from repurchase agreement can be determined by this formula

RP Interest income = Amount of loan x Current Repo Rate x (Repo Term in days/360

days)

For example; an overnight loan of Rs 1 million to a dealer at 12% Repo rate would yield interest

income of Rs 333.33.

RP Interest income = 1,000,000 x .12 x (1/360) = Rs 333.33

{Rose, marquis (2005) page 293}

TYPES OF REPO (ACCORDING TO MATURITY):

Overnight repos:

Overnight repos are 1 day loans

Term repos:

Term repos have terms of greater than 1 day—usually weeks to months

Open repo:

Open repo or continuing contracts are a contractual relationship that allows the borrower to

borrow funds up to a certain limit, without signing a new contract. However, each party has the

right to terminate the contract on a short notice. The interest rate on open repos is slightly higher

than on overnight repos.

PURPOSE OF REPO:

Large banks borrow from dealers and other non-bank institutions through Repo in order to avoid

deposit reserve requirements and prohibitions against their paying interest on deposit accounts,

while the dealers enter in RPs to borrow at the low cost RP interest rate in order to purchase

interest bearing securities. Companies & financial institutions eager the loan its temporary cash

surplus to avoid losing even a single day’s interest.

ADVANTAGES OF REPO:

The main benefit of Repo to borrowers is that the Repo rate is less than borrowing from a

bank.

The main benefit to lenders over other money market instruments is that the maturity of

the Repo can be precisely tailored to the lender's needs.

4. BANKER’S ACCEPTANCE:

The literal meaning of the term acceptance is approval. In financial terms acceptance means a

vow to pay a definite amount of money. The person who will pay is called as the promissory

while the one who will receive is the beneficiary.

The document which is the evidence of this promise is called a draft. When this draft tells the

promissory to pay the money on a predetermined specified date then this draft is termed as a time

draft. The promissory puts his

Signature

The word accepted on top of his signatures and

The date on which the amount will be paid.

Now the promissory is legally obliged to pay the amount as mentioned in the draft to the

beneficiary because it has been accepted properly by him according to all requirements of

official acceptance.

If the time draft is formally accepted by a bank then it becomes a banker’s acceptance.

In case of a bankers acceptance the initial promissory is obliged to pay the sum of money and the

interest money charged before or on the maturity date to the bank while the bank is obliged to

pay the money to the beneficiary. The bank becomes the primary obligor.

Banker’s acceptance is usually used in trade; mostly for international business but is also

frequently used for domestic dealing as well. The maturities of banker’s acceptance mostly range

from 30 to 180 days. It allows the international as well as national dealers to trade with each

other. As the dealing firms have not met or may even never meet; have a problem of trusting

each other. So banker’s acceptance minimizes their risk. The promissory uses the bank’s credit

worthiness instead. Hence the beneficiary is satisfied. Meanwhile the promissory also gets more

time to make the payments.

EXAMPLE TO ILLUSTRATE THE MECHANISM OF BANKER’S ACCEPTANCE:

Suppose that you own a software house and you need computers. You order a dealer in Japan to

send you ten computers on credit. Now that dealer does not know your credit worthiness. A very

easy way to resolve this problem is that you go straight to your bank with which you have a very

good past record. There you get a time draft issued on which the date you will pay the money is

mentioned.

Most probably the date mentioned will be one or two weeks later after getting the shipment. The

bank trusts you because of your good credit rating and it signs the draft adds its signature and

mentions the date. This draft has now become a banker’s acceptance. The draft is then sent to the

manufacturer who is very much satisfied now as he knows the banks credit rating.

According to Rose the importer secures a line of credit from his bank and sends the documents to

the importer. Now the foreign dealer can draw a time draft against the issuing bank. The exporter

goes to his bank which is called the accepting bank. Now this bank gives the importer that

specified sum of money and sends the shipment documents and the time draft to the issuing

bank.

The issuing bank after verifying stamps the word accepted on the draft. By doing this it has

become liable to paying that some of money to the bank. The accepting bank is paid that specific

sum of money.

So by deploying both of these ways a banker’s acceptance can be created. In essence whenever

any bank will agree to pay any importer on behalf of the exporter that document having all these

abiding will be termed as the banker’s acceptance.

SECONDARY MARKET FOR THE BANKER’S ACCEPTANCE:

There is a very strong and affluent market for it. The issuing bank can either keep it in his

portfolio or sell the bankers acceptance in the money market. It is sold at a discount from the

value which will be payable on maturity. In this way the seller is getting funds from the money

market hence it provides liquidity to the seller.

BA provides a very low risk interest income to the buyer. They are mostly sold at a spread over

t-bills and this rate is referred to as the BA rate. Some banks also purchase the BAs which are

nearing their maturity in order to increase their liquidity.

If the accepting bank which is the primary obligor fails to pay the amount the holder of the BA

(assuming the bank has sold the BA in the open market) has recourse back to the issuer of the

draft the secondary obligor.

The secondary obligor has the unconditional responsibility to pay the acceptance if the primary

obligor dishonors it. This characteristic makes the BA; referred to as a two-name paper, a safe

investment instrument usually with lower rates than might be available in a direct borrowing.

The BA’s marketability is limited only by the reputation of the accepting branch and the market

demand.

The net proceeds after the sale = the face amount of the acceptance - the discount rate (interest

rate*days into maturity*face amount) + the bank’s acceptance commission. The combination of

these is called the “all in” rate.

BA financing may be used by exporters, importers, domestic buyers and sellers, traders,

shippers, manufacturers, processors, distributors, or almost anyone involved in international or

domestic trade.

Capital Market

The market where investment instruments like bonds, equities and mortgages are traded

is known as the capital market.

The primal role of this market is to make investment from investors who have surplus funds to

the ones who are running a deficit.

The capital market offers both long term and short funds:

The different types of financial instruments that are traded in the capital markets are

Equity instruments 

Credit market instruments

Insurance instruments

Foreign exchange instruments

Hybrid instruments  

Derivative instruments

Types of capital market: 

There are two types of capital market:

Primary market

Secondary market 

Primary Market:

It is that market in which shares, debentures and other securities are sold for the first time for

collecting long-term capital.

This market is concerned with new issues. Therefore, the primary market is also called NEW

ISSUE MARKET.

In this market, the flow of funds is from savers to borrowers (industries), hence, it helps

directly in the capital formation of the country.

The money collected from this market is generally used by the companies to modernize the plant,

machinery and buildings, for extending business, and for setting up new 

business unit.

Features of Primary Market:

It Is Related With New Issues 

It Has No Particular Place 

 It Has Various Methods Of Float Capital: Following are the methods of raising capital in the

primary market:

i. Public Issue 

ii. Offer for Sale

iii. Private Placement

iv. Right Issue 

v. Electronic-Initial Public Offer 

 Secondary Market:

The secondary market is that market in which the buying and selling of the previously issued

securities is done.

The transactions of the secondary market are generally done through the medium of stock

exchange.

The chief purpose of the secondary market is to create liquidity in securities

If an individual has bought some security and he now wants to sell it, he can do so through

the medium of stock exchange to sell or purchase through the medium of stock exchange

requires the services of the broker presently, there are three main stock exchanges in

Pakistan.

The trading instruments in the capital market:

Debt Instruments which is used by either companies or governments to generate funds for

capital-intensive projects. When the instrument is issued by the federal government, it is

called a Sovereign Bond.

Equities issued by companies only and can also be obtained either in the primary market or

the secondary market.

Preference Shares issued by corporate bodies and the investors rank second (after bond

holders) on the scale of preference. The instrument possesses the characteristics of equity in

the sense that when the authorized share capital and paid up capital are being calculated, they

are added to equity capital to arrive at the total

Derivatives are those instruments that derive from other securities, which are referred to as

underlying assets (as the derivative is derived from them).

Capital Market in Pakistan:

Capital market is one of the most crucial indicators to demonstrate an economy’s health as it

serves as an imperative constituent of the financial sector. It acts as a medium of transforming

surplus capital available with non-productive sources to the dynamic channels of the economy.

Capital market has an important role in setting off domestic capital and directing it to fruitful

investments. A competent capital market can also offer a broad range of stirring opportunities

equally for domestic as well as foreign investors. Stock (equity) and Debt markets are jointly

called as Capital markets. The capital markets grant a platform for hoisting the long term

investment needs of businesses by means of equity and long term debt. It serves as an attraction

for investors with a long term investment perspective.

Capital Market offers an imperative alternative platform of long-term investment for enduring

and dynamic investments. It also helps in diverting strains on the banking system by

harmonizing long-term capital with long-term investments. Capital markets set a platform for

investment opportunities to support economic ethnicity decisive in escalating domestic savings

as well as investment ratios that are necessary for swift industrialization. It promotes the idea of

broader possession of industrious assets by undersized savers and facilitates them to extract

benefit from country’s economic expansion and wealth distribution. It encourages public-private

sector partnerships to promote contribution of private sector in prolific investments. Capital

markets have an evident role in transferring dynamic force of economic growth from public to

private sector to improve economic efficiency. There is great role of capital markets in reducing

resource gap and balances the endeavor in financing vital socio-economic progress, through

increasing long-term project based capital. The capital allocation efficiency improves through

viable pricing system for enhanced utilization of limited resources for improved economic

development.

Pakistan’s capital market has two important elements as an equity market, which is composed of

three stock exchanges and a transitional financial system extensively influenced by Non-Banking

Financial Institutions (NBFIs). Pakistan’s capital and stock markets have witnessed impressive

growth on account of market-friendly and investment-friendly policies pursued by the

government. The KSE-100 index (Pakistan’s benchmarked stock market) has increased from

11,348 points in January 2012 to 28,913 points in April 2014 - a rise of over 17,565 points or an

increase of 155 percent (Fig.6.1). Similarly aggregate market capitalization has increased from

Rs. 2,961 billion ($32.9 billion) in January 2012 to Rs. 7,116 billion ($72.2 billion) in April,

2014, showing a rise of over Rs.4155 billion ($39.3 billion) or an increase of 140 percent in

rupee term. The listed capital at KSE has increased from Rs. 1,048.44 billion as of end-

December, 2011 to Rs.1,153.18 billion in April, 2014.

Performance of Karachi Stock Exchange during 2013-14:

During FY14 (July-April), KSE 100 Index increased 38 percent and closed at 28913 points on

April 30, 2014. The huge rally in the stock market is an indication that the market participants

expect the economy in general and the listed companies especially will perform well over the

next few years.

The market rally since the General Elections held on the 11th of May, 2013 is primarily driven

due to the change of government in the country resulted in taking control of the present

government of PML(N). Consequently, the post-election market increased by more than 45

percent till April, 2014. Other reasons that pushed the market into an uncharted territory include

robust foreign interest, the healthy earnings growth and improvement in business sentiments.

Another reason is the investor moratorium applied in January, 2013 by the Securities and

Exchange Commission of Pakistan (SECP), in collaboration with the KSE which allows foreign

investors to bring investments to Pakistan with no questions asked about the money’s origin and

sources

On the economic front, GDP recorded 3.7 percent growth in FY13 and some of the local and

international financial institutions including SBP, IMF, World Bank, etc. has projected the GDP

to grow around between 3-4 percent and further to pick momentum from FY15 onwards.

However, the GDP for FY14 recorded a growth of 4.14 percent, much ahead of the estimated

growth by international agencies. The improvement in industrial growth came from the better

margins for domestic producers; capacity enhancement in paper, motor tires and iron and steel;

investment in alternate energy; strong construction growth and better financial conditions in

POL. Load shedding has been reduced due to significant reduction in the circular debt. Overseas

Pakistani workers remitted an amount of $12.89 billion during first ten months of current fiscal

year showing a growth of 11.45 percent compared with $11.57 billion received during the same

period of last year. The average Inflation recorded during July-April (2013-14) was 8.68%

beating the market consensus of above 10%, it is expected that full year CPI to average in single

digit. The IMF has also projected end year inflation about 8.8 percent and 8.1 percent for FY15.

The government’s interest in privatization of public sector entities will also bring improvement

in economic growth of the country. Growth of Large scale manufacturing has been strong during

this period. The fiscal deficit has been contained while the private sector credit has increased.

The fiscal authority has been able to borrow long term loans and rupee has appreciated against

the dollar. The foreign exchange reserves of SBP have increased noticeably due to issuance of

Eurobond and 3G / 4G licenses resulting in US $ 2 billion and around US $ 1.1 billion inflow

respectively. European Union has granted the Generalized Scheme of Preferences (GSP) Plus

status to Pakistan in December 2013.

This status will increase the access to the EU market through duty free imports of textile and

non-textile products. The grant of the GSP Plus status is effective from January 1, 2014. This is

indeed a positive development. The prospects of duty-free under the GSP Plus access for textile

and clothing suggest enormous scope for Pakistan’s exports expansion. Due to the above listed

developments, positive sentiments have been prevailing in the stock market since 11th May,

2013.

Description As on

11th May

2013

End

April

2014

%

growth

since 11th

May,

2013

KSE 100 Index 19,916 28,913 45.2

Total Market

Capitalization

(In billion)

Rs.

US$

5,050

51.3

7,116

72.2

40.9

40.7

Source: Business Recorder Research, Ministry of Finance calculations

A total of, 559 companies were listed at Karachi Stock Exchange with the listed capital of Rs.

1,153 billion (US $ 11.77 billion) with the market capitalization of Rs. 7,116 billion (US$ 72.2

billion) as at end-April, 2014. KSE 100 Index opened at 21,006 points on July 1, 2013 and

closed at 25,261 points at the end of calendar year 2013, showing a gain of 20 percent over this

period. The bullish trend in KSE is also continuing in 2014 with further gains. The KSE 100

index closed at 28,913 points level as on end April, showing a cumulative gain of 38 percent

during first ten months of current fiscal year. The benchmark index touched historical high of

29,458 points on April 16, 2014. The total traded volume in the Ready market for the July –

April period was more than 48 billion shares. The average daily volume has been recorded at

237 million shares as against the average daily turnover of 221 million shares in FY13.

 Profile of Karachi Stock Exchange

During the period July–April, the process of new listing on equity and debt segment remained

slow and only four companies were listed. In the later part of December 2013, subscription of

Engro Fertilizer IPO for 75 million shares at the rate Rs. 28.25 per share was very well received

by investors and was oversubscribed by 3.4 times. KSE launched numerous focused campaigns

to generate large scale awareness amongst individual savers regarding the role of capital market

in the overall context for their long term financial planning. In this regard, more than 20

programs have been conducted in collaboration with other market participants. To strengthen and

deepen the money market in line with the international best practices, KSE requested

government to allow trading of government securities through stock exchanges. Government has

accepted the proposal and the trading of government securities have been started through stock

exchanges. This will attract retail and international fixed income funds to invest in government

securities. Presently retail investors have little direct ownership of government bonds and bills.

Federal Minister of Finance and Economic Affairs has launched the trading of government debt

securities at stock exchange on February 18, 2014. KSE is actively working on the development

of Small and Medium Enterprises (SME) trading counter at stock exchange. The Small and

Medium size segment constitute nearly 90 percent of all the enterprises in Pakistan; employ 80

percent of the non-agricultural labor force; and its share in the annual GDP is 40 percent,

approximately. The small and medium enterprise is constrained by lack of financial resources

and requires a mechanism through which flow of funds can be observed into a small company or

new startup in the form of an investment rather than a loan. The Small and Medium Enterprises

(SMEs) play a catalytic role in the development process of most economies as they constitute a

major part of the industrial activity in these economies.

Sectorial performance of Karachi Stock Exchange:

Oil & Gas:

In this sector 12 Companies were listed at Karachi Stock Exchange. It is one of the most

dominant sectors in the stock market. In addition to Oil and Gas exploration companies, Oil

marketing Companies and Refineries are also listed in this sector. Due to increase in

consumption and change in well head prices, Pakistan Oil and Gas sector has shown good

profits, Oil & Gas sector continued to be one of the major market players in the current year.

Companies like OGDCL, PSO PPL, Mari Petroleum, Pak Refinery, etc led the current year’s

upsurge in the stock market. In 2013 total profit after tax was Rs. 165,911.25 million which was

Rs.162, 622.83 million in last year 2012.

Personal Goods (Textile):

In this Sector 175 companies (mostly textile) were listed in Karachi Stock Exchange, having

total paid up capital of Rs. 49,951.31 million with market capitalization of Rs. 347,967 million.

In 2013 this sector showed profit of Rs. 39,413.20 million as against the loss of Rs. (5,711.85)

million in years 2012. The sector comprises of 164 textile related companies. Good Export

orders make the sector to book profits. However, this sector could not show very good

performance in the third quarter due to sharp appreciation of rupee against dollar. It is expected

that due to grant of GSP Plus status to Pakistan by the European Union will further boost the

profitability of this sector in coming days and during remaining part of the current year.

Construction & Materials:

This sector comprises of 35 companies, with total listed capital of Rs. 76,580.83 million and the

market capitalization of Rs. 353,968.36 million. Like last year, the cement sector has seen

another great year because of low cost pressures, especially from imported coal, high cement

prices and stable demand due to higher consumption and good exports. Calendar year 2013 saw a

sharp decline in international coal prices that dropped 15-18 percent since January, 2013 due to

low economic growth in China and India – the two major coal importers in the world. Further,

other reason for the high growth in profitability of cement manufacturers is the rise in retail

prices. The sector showed tremendous growth during current financial year which translated into

good financial results compared to last year. The sector recorded the profit after tax at Rs.

38,901.87 million during 2013 compared to Rs. 20,782.84 million profit in year 2012.

Electricity:

Sector comprises of 17 companies and the listed capital was Rs. 140,199.96 million with market

capitalization of Rs. 193,659.56 million. The profit after tax of the sector was Rs. 28,825.54

million in 2013 as compared to Rs.20, 736.22 million in year 2012. The electricity sector

recorded above-average performance in 2013 with a return of 36 percent as yield spread against

government-backed securities grew. This was further supplemented by circular debt resolution in

2013.

Chemicals:

In this sector 33 companies are listed, having total paid up capital of Rs. 107,063.09 million and

the market capitalization was Rs. 593,127.66 million. In this sector Fertilizer manufacturing

companies are also listed and quoted. The total profit after tax in this sector during 2013 was Rs.

45,265.26 as compared to Rs. 38,045.93 million in 2012. Chemicals performed moderately in

2013 with returns of 15%. Due to declining margins, chemicals showed lackluster performance.

Automobile and Parts:

The sector comprises of 16 companies with the total paid up capital of Rs. 6,872.03 million and

the total market capitalization of Rs. 118,602.98 million. The profit after tax of this sector was

Rs. 8,665.75 Million in 2013 this was Rs. 7,426.94 million in year 2012.

Fixed Line Communication:

The sector comprises of 5 companies which includes PTCL with a capital of Rs. 51,000 million.

The total market capitalization in this sector remained Rs. 111,543.48 million in 2013. The profit

after tax of this sector was Rs. 10,033.74 million in 2013 and outperformed other sectors. This

sector showed loss of Rs. (14267.27) million in 2012.

Commercial Banks:

The sector comprises of 23 listed banks with the listed capital of Rs. 369,719.28 million and

market capitalization of Rs. 1,468,232.17 million. The profit after tax of this sector was Rs.

109,325.46 in 2013 which was Rs. 114,936.0 million in previous year 2012. The sector could not

perform well due to less earnings due to limited advance and consumer financing because of

high interest rates. Even then, few banking scripts performed outstandingly including HBL and

UBL.

Pharma and Bio Tech:

The sector comprises of 9 listed pharmaceutical companies with the paid up capital of Rs.

5,368.09 million and Rs. 139,729.75 market capitalization. This total profit after tax of this

sector was Rs. 5,120.54 million in year 2013 which was Rs. 5,149.74 million in year 2012.

Food Producers:

The sector comprises of 51 companies with the dominance of sugar related companies. The total

paid up capital was Rs. 19,767.46 million and market capitalization was Rs. 702,988.40 million.

The profit after tax of this sector was Rs. 20,620.92 million in year 2013 as against Rs. 12,544.90

million in 2012. Some scripts in this sector performed well like Nestle, Engro foods, etc.

Performance of Selected Blue Chips:

The Index of KSE is primarily influenced by some blue chip companies. During the first ten

months of the current fiscal year 2013-14, the combined paid-up capital of fifteen big companies

(Table-6.3) was Rs. 176.31 billion, which constituted 15.29 percent of the total listed capital at

KSE. These fifteen companies earned a profit after taxation of Rs. 285.77 billion in the fiscal

year up to April 2014. Out of total profit after tax, the share of OGDCL and Pakistan Petroleum

Limited stood at Rs. 132.73 billion representing 46.44 percent of the fifteen big companies. For

the period end-April, 2014, Habib Bank Limited and MCB Bank Limited’s after-tax profit were

Rs. 23.30 billion and Rs. 21.50 billion, respectively. Earnings per share of the top rated

companies ranged from 2.59 in the case of National Bank of Pakistan to 50.84 in respect of

Pakistan State Oil Co. This indicates that the business environment in the fiscal year 2013-14 has

improved considerably for the blue chip companies.

Lahore Stock Exchange:The leading market indicators witnessed positive trends in Lahore Stock Exchange. The LSE -25

Index, which on 30th June 2013 was at 4,370.7 level increased to 5,131.1 levels as on end March

2014 with listed capital increased from Rs 1,042.2 billion to Rs 1,096.1 billion. Total turnover of

the shares on LSE during July- March 2013-14 is 0.5 billion shares as compared to 1.0 billion

shares in the corresponding last period, with fund mobilization of Rs 32.5 billion and

market ,capitalization is Rs.6,258.2 billion during July- March 2013-14.

Profile of Lahore Stock Exchange:

Islamabad Stock Exchange:The securities market showed a kind of dynamism during the period under review. It set new

records in the wake of general elections and resulting political stability. ISE-10 index which is

the principal index of the Exchange was 3,904.6 points on July 01, 2013 increased to 4,440

points as on end March, 2014 recording an increase of 13.7 percent during first 9 months of

current fiscal year. The number of listed companies increased from 210 in June 2013 to 262 as

on end March 2014. The total listed capital grew to Rs.890.9 billion from 871.1 billion during

this period. The market capitalization also recorded an increase of Rs.994.50 billion which was

24.75 percent high as compared to last year.

Profile of Islamabad Stock Exchange:

New listing at Stock Exchanges:During the period July 2013 to March 2014, approval was granted by Securities and Exchange

Commission of Pakistan (SECP) to four equity issues under section 57(1) and 62 of the

Companies Ordinance, 1984 i.e. offer for sale of 37.984 million shares of Lalpir Power Limited ;

18.75 million ordinary shares of Engro Fertilizers Limited; issuance of 25.166 million shares of

Avanceon Limited and issuance of 25 million ordinary shares of Hascol Petroleum Limited to

the general public, institutional investors and high-net-worth individuals. During the period

Pakistan International Bulk Terminal was listed, with a paid-up-capital of Rs. 545.765 million,

on the KSE under Regulation No. 25 of the Listing Regulations of KSE.

Debt Capital Markets:A well-developed corporate bond market is essential for the growth of the economy as it

provides an additional avenue to corporate sector for raising funds for meeting their financial

requirements. During the period July 2013 to March 2014 two issues of listed debt instrument

were offered to the general public, i.e. offering of Term Finance Certificates (TFC) of PKR

4,000 million (TFC of PKR 3000 million for a tenor of 3 years and TFC-2 of PKR 1000 million

for a tenor of 5 years) by Pakistan Refinery Limited and offering Sukuk of PKR 6000 million

(Sukuk-1 of PKR 750 million for a tenor of 13 months, Sukuk-2 of PKR 3750 million for a tenor

of 3 years and Sukuk-3 of PKR 1500 million for a tenor of 5 years) by K-Electric Limited

(formerly Karachi Electric Supply Company Limited). There was no pre-IPO placement in both

the issues and the entire amount was offered to the general public including both individual and

institutional investors.

Government Debt Securities Trading:

To accelerate growth in the debt market, efforts were made for trading of Government Debt

instruments at the stock exchanges in coordination with the federal government. In this regard a

special purpose committee was formed having representation from SBP, SECP, KSE, CDC and

NCCPL for the purpose. The committee finalized the model for trading of government securities

at stock exchanges and their settlement. On January 27, 2014, the SECP approved the regulatory

framework for trading of government debt instruments at the KSE, and the soft launch of trading

in government securities at KSE was successfully made on January 31, 2014. The formal launch

was made by the Minister Finance on February 18, 2014. Scrip wise transactions in Government

Debt Securities on the trading platform of stock exchange for the period from January 31, 2014

to May 02, 2014 is given hereunder; further during this period transactions amounting Rs.

331,300,000 were carried out.

Employee Stock Option Scheme:

Employees Stock Option Schemes are issued not only to reward employees but also as a

retention tool and to build long term loyalty of employees to their workplace. To reward

performance, encourage productivity and increase employee involvement companies in Pakistan

have increasingly started offering stock options to its employees. The Stock Option Schemes are

approved by SECP under the Public Companies (Employees Stock Option Scheme) Rules, 1999.

During the period under review, SECP approved the following two Employees Stock Option

Schemes;

a. Bank Alfalah Limited for up to 40 million shares to its employees

b. Avanceon Limited for up to 5 million shares to its employees.

Capital Market Reforms and Development Activities:

Deep, liquid and efficient capital markets are critical for the development of Pakistan’s economy.

During the period under review; the SECP in line with its mandate to develop a modern, fair and

efficient capital market; continued with its agenda to improve risk management, corporate

governance, enhance transparency, investor protection and develop new

products/systems/markets. The highlights of key reform measures introduced during the period

under review are as follows:

Code of Conduct for Credit Rating Agencies:

In order to review the role and responsibilities of CRAs, the Commission constituted a

Committee having representation from SECP, State Bank of Pakistan (SBP) and both the

domestic CRAs. SECP in light of the recommendations of the Committee has revised the

existing Code of Conduct for CRAs. The revised Code dated January 13, 2014 has been

formulated in line with International Best Practices and has replaced the earlier Code of Conduct

for Credit Rating Agencies (CRAs) dated February 17, 2005.

Commercial Papers Regulations, 2013:

Commercial Papers Regulations, 2013 have been notified on December 04, 2013.Commercial

Paper (CP) is an unsecured short term debt instrument issued by highly rated companies in the

form of promissory note. In 2002, SECP had issued guidelines for Issue of Commercial Papers.

In order to appropriately regulate CP issues and to facilitate the CP issuers, the guidelines have

been reviewed and replaced with the regulations.

Listing of SMEs on the Stock Exchange:

Small and Medium Enterprises (SMEs) plays vital role in the development of a country. SMEs

are considered to be an important segment of the economy as they have the potential to create the

economic as well as social growth. It is therefore essential to minimize the constraints and to

provide a conducive environment for the growth and development of SMEs. Availability of

cheaper source of funds is crucial

for the growth as well as survival of SMEs. Financial constraints sometime compel SMEs to

close down their businesses which ultimately create negative impact on the economy as well as

cerates unemployment. Since there are limited fund raising alternatives available to SMEs,

therefore, it becomes necessary to provide them with an updated regulatory framework which

facilitates efficient fund raising. Listing of a company on the exchange gives better valuation to

the company. The listed SMEs will reveal their wealth in the medium to long term and expected

to create the wealth creation for the promoters and the investors. The Securities and Exchange

Commission of Pakistan (SECP) has approved the Regulations for listing of SMEs for the

Islamabad Stock Exchange. The Regulations in addition to certain pre-requisite conditions

provide a set of procedures for issue, listing and trading of shares of SMEs. Now SMEs can raise

funds from the capital market, through listing, for meeting their financial needs for executing

new projects and/or expansion of their existing businesses.

Introduction and implementation of e-IPO:

In order to facilitate the general public during IPOs, SECP has introduced the concept of e–IPO,

i.e. electronic submission of subscription form. An e–IPO facility will: Enable the investors to

make application for subscription of shares via internet (e- Banking/ATMs) Facilitate

simultaneously, companies that intend to raise fund from the capital market through IPO, and the

general public applying

for subscription of shares Bring transparency and efficiency to the IPO process.

The e–IPO facility was first used successfully in the offer for sale of shares of Aisha Steel Mills

Ltd, where United Bank Limited for the first time provided e–IPO facility to its account holders.

Later the same bank has successfully offered e– IPO facility in the IPOs of Lalpir Power

Limited, Engro Fertilizers Limited, and Avanceon Limited. For further development, a

committee has been constituted with representatives from the SECP, CDC, Banks, Share

Registrar, and the Stock exchange. The Committee in coordination with CDC and Banks is in the

process of devising a centralized system for handling e-IPO applications.

Separate Portal for IPO/Capital Issue Matter:

In order to facilitate the issuers, consultants, researchers as well as other stakeholders, a separate

portal on SECP’s website has been created under the name “Capital Issues and Public

Offerings”. Under this portal all material/information relevant to capital issues and public

offerings has been placed which includes: detail of equity issues; detail of debt issues; Listed

Term Finance Certificates (TFCs); privately placed TFCs; and Sukuks and Commercial Papers.

Moreover, redemption statuses of debt securities as well as laws, rules, regulations and

guidelines applicable on issue of securities have also been placed under the said portal. Further,

List of Registered Debt Securities Trustees, List of Underwriters to the issue, List of

Ballotters and Share Registrars to an issue, and List of advisors/consultant to an issue are also

available under the said portal.

Future Roadmap:

The SECP envisages introduction of key structural and regulatory reforms: development of

equity, derivatives markets, debt, commodities and currencies markets, and measures for

improving governance, risk management, efficiency and transparency in capital market

operations. Future roadmap includes;

Post-demutualization reforms:

The SECP in collaboration with the stock exchanges is in the process of introducing

consequential reforms which are essential for taking the exchanges forward in the demutualized

setup. The stock exchanges are in the process of bringing in strategic investors to benefit from

their extensive expertise and technological knowhow, while at the same time bringing foreign

investment, and broadening the investor base. Simultaneously, efforts will be made for listing of

the stock exchanges and sale of shares to the general public in terms of the demutualization law.

The possibility of integration of the three stock exchanges is also being explored to benefit from

operational synergies in line with international best practices.

Commodities Market development:

For further diversification of the product portfolio in the commodities market, the futures

contracts of Brent Crude Oil and Copper are being reviewed for introduction at PMEX. Also,

PMEX has formulated comprehensive criteria for its membership which will be implemented

after SECP approval. As for the improvement of regulatory framework, the regulations

governing default management at PMEX are also being considered for approval to safeguard the

interests of investors, in the event of default by a PMEX Broker

Development of new Products and Systems:

Future SECP agenda includes: listing and trading of stock options, cross listing of foreign and

domestic indices at Pakistani and foreign stock exchanges, activation of the market for Exchange

Traded Funds (ETFs) and boosting activity in the index futures market. Further, avenues are

being explored for introducing the latest risk management techniques, including introduction of

the Standardized Portfolio Analysis of Risk (SPAN) margining regime in the derivative market

segments

Centralized Know Your Client (KYC) Organization:

To facilitate the securities market investors, NCCPL will act as a Centralized KYC Organization

whose objective will be to register and maintain investors’ KYC records in line with the

international best practices pertaining to KYC and Customer Due Diligence (CDD) policies.

KYC records will be available for access by all market intermediaries, thus avoiding duplication

of effort and bringing uniformity to the KYC process.

Establishment of SIPC:

The collapse of brokerage houses results in a large number of investor complaints. The stock

exchanges strive to settle these investor complaints through limited recourse on the assets of

defaulting brokers for example, by disposing their trading rights and other collaterals deposited

with the exchanges. The concept of SIPC exists in many countries such as USA, China, and

Malaysia etc. and is usually implemented through specialized legislation to enable the SIPC to

create recourse on the assets of a defaulting brokerage house in favor of clients. The SIPC

maintains an adequate pool of funds to compensate investors to the maximum extent in the event

of default of their broker/ custodian. It is envisaged that a Securities Investor Protection

Corporation (SIPC) should be established to cater for such situations.

Establishment of a Brokers’ Association:

Considering the important role of market intermediaries, the possibility of establishing a brokers’

association is being assessed. This will provide an effective platform for the Stockbroking

community to voice their concerns to the government and regulatory bodies, and ensure

professional training and exposure to the intermediaries, while creating awareness about capital

market issues.

Mutual Funds:

The total size of the mutual funds industry stood at Rs.452.378 billion as of March 31, 2014 as

compared to Rs.417.80 billion as of December 31, 2013, showing an increase of Rs 34.5 billion

or 8.2 percent over the period. The total number of funds stood at 157 on March 31, 2014 as

compared to 153 on December 31, 2013. Money market funds (both Conventional and Shariah

Compliant) dominated the Assets under Management (AUM) of the industry with the largest

share of the mutual fund industry i.e. 34.68 percent. Equity funds (both Conventional and

Shariah Compliant) held the second largest market share i.e. 34.38 percent, followed by Income

funds (both Conventional and Shariah Compliant) with market share of 21 percent.

Portfolio management industry in Pakistan is steadily growing under

discretionary/nondiscretionary portfolio managed by Asset Management Companies (AMCs).

The portfolio industry have reached to the tune of Rs.68.17 billion as on March 31, 2014 as

compared to Rs. 56 billion as on June 30, 2013 registering a growth of Rs. 12.17 billion or

21.7% during the period. The SECP, in its endeavor to safe guard the interest of unit holders and

to facilitate the industry, took following initiatives during the year for the development and

growth of industry.

The SECP has prescribed detailed requirements for outsourcing of functions performed by an

Asset Management Company (AMC) on behalf of Collective Investment Schemes (CIS). The

SECP has provided flexibility to AMCs in terms of delegating certain functions to a third party

service provider, except for some core duties such as investment decision making, risk

management and compliance. This flexibility would allow AMCs to opt for outsourcing of its

basic functions, resulting in better focus on its core business / operations.

To counter miss-selling of units of mutual funds, SECP has prescribed detailed norms for

selling of units of CIS including prohibiting AMCs to engage, directly or indirectly in the

mis-selling of units of CIS, and sale of units by making a false or misleading statement,

concealing or omitting material facts relating to the CIS and concealing the associated

risk factors.

In order to bring consistency in valuation methodology of Ijarah Sukuks and to bring the

practices being followed by the industry in line with the Regulatory framework, the

Commission directed the AMCs to use PKISRVE (Sukuk) rates for valuing the GOP

Ijarah Sukuks to determine net assets of CIS under their management

On the product innovation front, the Commission allowed the industry to launch a fund

based on

Constant Proportion Portfolio Insurance (CPPI) methodology with direct exposure in

equities and money market instruments.

Non-Banking Financial Services

Non-banking financial services are being provided by leasing companies and investment finance

companies (Investment Banks) and housing finance companies. As of March 31st 2014, there

were 8 leasing companies, and 7 investment finance companies. Since a few years these entities

have been facing a number of problems due to which their growth and development has been

rather slow. The SECP in order to ensure the development of these entities has carried out review

of the whole business model and prevalent regime of non-banking financial services taking into

account global best practices, as well as the interests of all the stakeholders. Amendments are

being made in the Regulatory framework for NBFC’s in the light of the NBFC sector report

giving way to a relaxed regime.

Significant amendments are as follows;

A regulatory regime has been developed with significantly reduced equity requirements

to encourage non-deposit taking lending NBFCs.

Concept of Islamic Lending NBFC is being introduced. Such an NBFC shall conduct its

business in accordance with Islamic Shariah principles.

With the purpose of facilitating and providing finance to poor persons and

microenterprises, Micro Lending NBFC’s are being introduced.

A new set of regulations has been incorporated for Discount Houses.

Scope of housing finance companies has been broadened to undertake commercial

housing finance activities.

Introduction of various measures such as capital adequacy ratio, capping of deposit

taking activities, reduction in exposure limits, rationalizing leveraging capacity, etc. to

protect interest of general public.

Modarabas:

The modarabas sector is an important component of the Pakistani financial infrastructure and is

playing a vital role in addressing the needs of SME sector through various Islamic and

conventional products.

The modaraba industry, despite several impediments, has contributed significantly over the past

years. Currently, 42 registered modaraba companies are in existence and total number of

operational modarabas are 27. During the period under review, 3 new companies were registered

as modaraba companies under the Modaraba Ordinance, 1980. These companies are expected to

float modarabas in near future. As of March 31, 2014, the aggregate paid up fund of the

Modaraba was Rs9.61 billion and total assets of the Modaraba sector stood at Rs30.83 billion,

against Rs29.77 billion on Feb 28, 2013. Similarly, total equity of the Modaraba sector was

Rs14.36 billion which shows an increase of Rs0.48 billion as compared to Rs13.88 billion during

the previous year. For the financial year ended June 30, 2013, out of 27 operational Modarabas,

16 modarabas declared cash dividends whereas one Modaraba announced stock dividend. SECP

is committed towards making overall nonbanking finance sector including modaraba vibrant and

successful. In this context, in line with international best practices, a number of reforms for

development of overall non-banking finance sector are being considered. The SECP is planning

to introduce structural changes in the regulatory regime. The specific changes for modarabas

include empowering the certificate holders of Modarabas, introducing the concept of AGM and

enhancing the management fee etc. to ensure more conductive regulatory environment.

Voluntary Pension System:

The last two decades have witnessed global pension reforms. In high-income countries, the

driving force has been the threat that the current pension systems will become unaffordable as

demographic

Developments presented a major risk. The countries that were in the process of transition from

command

Economy to market economy confronted the challenge of introducing a public pension system in

under socialist system. However, the demographic change and affordability have been the

driving force in these countries for reforms. It is anticipated that Pakistan shall also face similar

challenges in the near future.

Lately, the Government of Pakistan has been considering reforming the current pension system.

Luckily, the dependency ratio at this point of time is extremely favorable for Pakistan to shift

from defined benefit system to defined contribution system. While reforms at the national will

take some time, the SECP has introduced Voluntary Pension System (VPS), with the approval of

the Government of Pakistan. VPS envisages contributions by Pakistani nationals in a pension

fund approved by the SECP. The amount accumulated in a pension fund during working life can

be used to provide a stream of income to its members after retirement. The government has given

tax incentives to individuals under the current tax regime.

Private pension funds under the 2005 Voluntary Pension System (VPS) Rules were introduced in

2007. The size of pension funds remained stagnant during the initial years mainly due to lack of

awareness about the product, adverse market conditions, and fiscal inconsistencies. However,

since then, pension funds have shown significant growth which can be attributed to favorable

market conditions, positive changes in the tax regime, launch of new pension funds and increase

in number of participants (investors). So far, 13 pension funds have been launched under the

VPS. The size of pension funds has grown gradually. Following is the current status.

Date No. of pension funds Net assets

(Rs. in million)

31-DEC-13 13 5,986

31-MAR-14 13 6,669

The government has been endeavoring to bring parity among retirement schemes. As a result a

number of improvements have been brought in the tax regime governing VPS and other

retirement schemes in consultation with FBR. However, certain aspects are yet to be reformed.

Recent changes in the tax laws include:

The amount received as monthly installment from an income payment plan will be

exempted from income tax under the 2001 Second Schedule of ITO

Withdrawal of balance transferred to a VPS account from a recognized provident fund

will also be tax exempt in terms of the 2001 Second Schedule of ITO

To encourage funding of retirement schemes VPS needs to be made interchangeable with

other retirement schemes such as gratuity and superannuation funds. This will encourage

funded schemes leading to accumulation of assets and efficient deployment of retirement

savings.

National Savings Schemes (NSS):

The Central Directorate of National Savings (CDNS) is an attached department of the Finance

Division and perform deposit bank functions by selling government securities through its

network of savings centers spread all over the country. There are more than 6 million investors

through 373 branch network in National Saving Schemes (NSS). Presently, Defence Saving

Certificates, Regular Income Certificates, Special Savings Certificates/Accounts, Bahbood

Saving Certificates, Savings Account, Pensioners’ Benefit Account and Prize Bonds are in

operation. Some of the popular schemes are discussed below:

Defence Savings Certificates:

The Government of Pakistan introduced Defence Savings Certificate scheme in the year 1966.

The scheme has specifically been designed to meet the future requirements of the depositors.

This is 10 years maturity scheme with built in feature of automatic reinvestment after the

maturity. These certificates are available in the denominations of Rs.500, Rs.1000, Rs.5,000,

Rs.10,000, Rs.50,000, Rs.100,000, Rs.500,000 and Rs.1,000,000. These certificates can be

purchased from any National Savings Centre (NSC), Pakistan Post Offices (PPO), Authorized

branches of Scheduled Banks and State Bank of Pakistan (SBP). The minimum investment limit

is Rs.500/-, however, there is no maximum investment limit in this scheme. These certificates are

cashable at par any time after the date of purchase. However, no profit is payable if encashment

is made before completion of one year. The average compound rate of return on maturity

presently works to 12.26 percent p.a. Exemption of deduction of Withholding tax has been

withdrawn w.e.f 01-07-2013 on profit of investment up to Rs.150,000 . The profit earned on

these certificates is subject of deduction of 10 percent withholding tax at source. The Zakat is

collected at source as per rules.

Special Savings Certificates (Registered):

Keeping in view the periodic needs of depositors, this three years' maturity scheme was

introduced in February, 1990. These certificates are available in the denomination of Rs.500,

Rs.1000, Rs.5, 000, Rs.10,000, Rs.50,000, Rs.100,000, Rs.500,000 and Rs.1,000,000. Profit is

paid on the completion of each period of six months. The minimum investment limit is Rs.500/-,

however, there is no maximum investment limit in the scheme. These certificates are cashable at

par any time after the date of purchase. However, no profit is payable if the encashment is made

before completion of six months. At prevailing rates, the profit is paid at the rate 11.40 percent

p.a. for 1st five profits and at the rate 12.00 percent p.a. for the last profit. However, if the profit

is not withdrawn on due date it will automatically stand reinvested and would be calculated for

further profit on completion of the next 06 months' period. Similar rules exist for deduction of

Tax and Zakat on the profit on these certificates.

Bahbood Saving Certificates:

Keeping in view the hardships faced by the widows and senior citizens, this ten years' maturity

scheme was launched by the government on 1st July, 2003. Initially the scheme was meant for

widows only, however, the government. later decided to extend the facility for senior citizens

aged 60 years and above with effect from 1st January, 2004. These certificates are available in

the denominations of Rs.5, 000/-,

Rs.10,000/-, Rs.50,000/-, Rs.100,000/-, Rs.500,000 and 10,00000/-. Profit is paid on monthly

basis reckoned from the date of purchase of the certificates. The minimum investment limit in

this scheme is Rs.5,000/-, whereas, the maximum limit is Rs.3,000,000/-. Investment in allowed

in multiple of

Rs.5,000/-.At the prevailing rates monthly profit of Rs.1170/- is paid on investment of each

Rs.100,000/-. This way the profit rate works to 14.04 percent p.a. The withholding tax is not

collected on the profit earned on these certificates.

The investment made in this scheme is also exempted from Zakat.

Regular Income Certificates:

Keeping in view the monthly requirements of the general public, this five years' maturity

scheme was launched on 2nd February, 1993. These certificates are available in the denomination

of Rs.50,000, Rs.100,000, Rs.500,000, Rs.1,000,000, Rs.5,000,000 & Rs.10,000,000/=. Profit is

paid on monthly basis

Reckoned from the date of issue of certificates. The minimum investment limit is Rs.50,000/-,

however, there is no maximum investment limit in this scheme. At the prevailing rates monthly

profit of Rs.990/- (excluding withholding tax) is paid on investment of each Rs.100,000/-. This

way the profit rate works to 11.88 percent p.a. The profit earned on these certificates is subject to

deduction of 10percent withholding tax at source. However, the investment made in this scheme

is exempted from collection of Zakat.

Pensioner’s Benefit Account:

Keeping in view the hardships faced by the pensioners, this ten years' maturity scheme was

launched by the government on 19th January, 2003. The deposits are maintained in the form of

accounts and the profit is paid on monthly basis reckoned from the date of opening of the

account. The pensioners of Federal Government, Provincial Governments, Government of Azad

Jammu & Kashmir, Armed Forces, Semi Government and Autonomous bodies are allowed to

invest. The minimum investment limit is Rs.10,000/- , whereas, the maximum limit is

Rs.3,000,000/-. If an investor has already opened an account, he is eligible to invest only two

subsequent deposits in that account. At the prevailing rates monthly profit of Rs.1170/- is paid on

investment of each Rs.100,000/-. This way the profit rate works to 14.04 percent p.a. The

withholding tax is not collected on the profit earned on the deposits made in this scheme. The

investment made in the scheme is also exempted from Zakat.

Derivatives Market: Definition:

A financial instrument whose characteristics and value depend upon the characteristics and the

value of an underlying asset typically a commodity, bond, equity or currency. Examples of

derivatives include futures and options

Characteristics:

A derivative is a financial instrument or other contract with all three of the following

characteristics:

Its value changes in response to the change in the underlying asset i.e. commodity price,

exchange rate

It requires no initial net investment or the initial net investment is smaller than would be

required for other types of contracts that would be expected to have a similar response to

changes in market factor

It is settled at a future date

Derivatives – Evolution of Derivatives:

If one examines the evolution of derivative markets and instruments the

Progression has been as follows:

Derivatives – Evolution of Derivatives

Forward Contracts

Futures Contracts

Options

Financial Engineering

Exotic Options

Types of Derivatives: Forward: A customized, risk-exposed contract for a future trade

Futures: A standardized, exchange-traded, daily-settled forward

Swap: A multiple of forwards with periodic settlements

Option: A forward synthesized with a risk-free asset

e.g Derivative, Dependent, Contingent, Conditional, Synthetic, Hybrid,

Flexible, Dynamic, Adaptive, Proactive, Versatile.

Derivative Market in Pakistan:

Derivatives – Characteristic:

Forward:

A forward contract calls for the delivery of an asset (real or financial) at a future date for

a predetermined price.

Informal, private, customized and risk-exposed (because of inherent, strong incentives to

default) waiday ka sauda at local exchanges.

Futures:

A formal, standardized exchange-traded contract in which the underlying asset will be

delivered on a future date at a specified price.

Cash-Settled Futures (CSF) at the KSE – Yet to Gain Popularity:

Introduce early in 2007. Not gained popularity at all. Presently 15 companies are available for

these cash-settled futures.

Standard contract is of 30, 60 and 90 day duration, with daily marked-to market of losses &

gains. There are necessarily an equal number of buyers and sellers in the market and thus smooth

settlement on the last day of the contract is ensured.

Mutual fund is not allowed to trade in future as per Section 58 of NBFC regulation.

Not gaining popularity because of the availability of other resembling leveraging instrument of

CFS and also because of liking for deliverable futures for various reasons. Remember word

underlying asset in definition

However, on the recommendation of the committee CFS MK II and deliverable futures have

been discontinued recently.

Types of Futures:

Stock futures – Tracks the performance of a SCRIP

Stock Index futures – Tracks the performance of an INDEX

Both can be further classified into two types:

Cash Settled Futures

Deliverable Futures

Internationally cash settled futures are more popular (Available in Pakistan).

Derivatives - User of Derivative Products:

Derivatives markets whether OTC or exchange traded provide a platform for trading of risks.

These markets exist to facilitate the transfer of market risk from individuals or institution that

wish to avoid such risks or who are better equipped to manage them. The users of Derivative

Products can be broadly categorized into three groups:

Hedgers – who locks in future prices of products and commodities that are essential to

their business?

Speculators – are diverse group that includes day traders, financial institutions etc based

on their expertise and knowledge take position to make profit.

Arbitragers – are professional individuals and adhoc organization that specialize in

espying and taking advantage of price differential in underlying or derivative instrument

Derivative instruments are used by broad spectrum of market players with varying investment

horizons and risk preferences/appetite.

a. Individuals – They prefer option because of their leveraging or gearing features

b. Institutional Investor – They use derivative in their Asset allocation strategy

c. Corporate Treasurer – use derivative for both hedging exposure and for enhancing

yields

d. Banks/Other Financial Intermediaries – are attracted towards this instrument for their

strategic risk management features. Desk and floor traders capitalize on their superior

market information and use derivative to

Speculate

Hedge speculative position

Derivatives _ Available in Pakistan:

Futures & Forwards Contracts:

Forward:

A forward contract calls for the delivery of an asset (real or financial) at a future date for a

predetermined price.

Informal, private, customized and risk-exposed (because of inherent, strong incentives to default)

waiday ka sauda at local exchanges.

Futures:

A formal, standardized exchange-traded contract in which the underlying asset will be delivered

on a future date at a specified price.

Mechanics of Futures Trading:

1. Mark to Market

Daily Profit/Loss Recognition

As the day's trades are completed, all futures contracts are marked to the market at the settlement

price.

(Futures = a series of one-day forwards)

While the credited profits are withdrawn able, the trader must replenish the account if it falls

below the maintenance margin.

Margin call: When the market moves against the position by:

(Initial Margin - Maintenance Margin)

2. Deliverable Futures (at the KSE) _ (Discontinued recently)

Investors can BUY (go long) or SELL (go short) in a future, depending upon his / her

view about the stock. Shares of 42 companies are eligible for trading on the futures

counter at the KSE.

Standard contract of up-to five-week duration. In the last week of every month, the

contract for the next month is opened (roll-over week). First Wednesday of next month is

the settlement date.

Excessive positions / trading discouraged to avoid / reduce manipulation. Risk

management is stringent (client-wise and broker-wise position limits are in place).

‘Provisional trading’ at the time of the IPO of a share is also an example of futures

trading.

3. Ready-Future Hedging – has been the most common use of Deliverable Futures

Commonly used by fixed income investors (AMCs Fixed income funds) to earn through

‘spread transactions’. That is, typically the price of a future is higher than the ready

market price of that share. So BUY in ready and SELL the same share in the futures

contract to earn a spread).

For example:

Price per share Bank Al-Falah on the ready market Rs 50.90

Price per share Bank Al-Falah on the futures market Rs 51.25

Difference / spread Rs 0.35

Days between the settlement of the futures market transaction and that of the ready

market

= 5th Dec ‘07 – 13th Nov ‘07 = 21 days

Gross spread earned is = (Rs 0.35 / Rs 50.90) x (365 / 21) x 100 = 11.95%

The gains can be potentially higher if there is an opportunity to ‘reverse’ the spread

transaction before the settlement date)

4. Cash-Settled Futures (CSF) at the KSE – Yet to Gain Popularity:

Introduced early in 2007. Not gained popularity at all. Presently 15 companies are

available for these cash-settled futures.

Standard contract is of 30, 60 and 90 day duration, with daily marked-to market of losses

& gains. There are necessarily an equal number of buyers and sellers in the market and

thus smooth settlement on the last day of the contract is ensured.

Mutual fund are not allowed to trade in future as per Section 58 of NBFC regulation

Not gaining popularity because of the availability of other resembling leveraging

instrument of CFS and also because of liking for deliverable futures for various reasons.

Remember word underlying asset in definition

However, on the recommendation of the committee CFS MK II and deliverable futures

have been discontinued recently.

Future Market almost everything:

Grains & Oilseeds: wheat, corn, oats, soybeans, red beans, rye, rice, barley, rapeseed,

flaxseed, black seed,.

Foods & Fibers: cocoa, coffee, frozen OJ, sugar, cheese, flour, potatoes, copra, dry milk,

Livestock & Meat: live cattle, feeder cattle, hogs, piglets, pork bellies, lamb, chicken,

Metals: copper, gold, silver, zinc, platinum, lead, tin, nickel, palladium, aluminum alloy,

Oil & Gas: crude oil, heating oil, unleaded gasoline, natural gas, gas oil, propane,

Other Materials: cotton, wool, lumber, rubber, yarn, raw silk, dry cocoon, scrap metals,

fertilizers,

Types of Futures:

Stock futures – Tracks the performance of SCRIP

Stock Index futures – Tracks the performance of an INDEX

Both can be further classified into two types:

Cash Settled Futures

Deliverable Futures

Internationally cash settled futures are more popular. (Available in Pakistan)

Stock Futures

Stock Future in Pakistan:

Stock Futures were introduced at local bourses in September 2001, almost the same time as in

India. At beginning, investor’s awareness in Pakistan was obviously low but gradually investor

understanding regarding stock futures has increased and current stock futures are frequently used

as a source of leveraging at KSE, Fixed income funds size

During 2007-2008 average daily volume in future counter has been 26.81% of the total volume

traded at ready markets

Currently 42 stocks are trading on the futures counter at KSE vs. 119 scrip’s in India

Ready Future Hedging:

Commonly used by fixed income investors to lend to leveraged investors without taking price

risk

To Hedge price risk, players take opposite positions (buy in ready and sell in future contract)

Example:

Bought PTC in ready market @ PkR47

Settlement in 1 month

Sold PTC in a future contract @ PkR47.50

End of month profit is PkR0.50, which is 12.8% annualized yield

Hedging with Futures - Going Long:

Long hedge: Buy futures contract

Objective: Benefit from a rise in a stock price

Typical use: A investor whose view is that the market or stock price is going to go up, by the

agreed delivery date

Example:

PTC is trading in ready market @PkR47.00, i.e. PkR 47,000 investment

PTC future contract is trading @PkR47.50, i.e. PkR47, 500 for 5,000 shares at 20% margin

If the market price of PTC goes up by PkR1.5 in 1 months time (future settlement date), the

respective gain in the ready market would be, PkR1, 500 while if bought in the future contract,

the gain would be PR7, 500. Thus with approximately the same investment, the return is much

higher in futures market

Hedging with Futures - Going Short:

Short hedge: Sell futures contract

Objective: Protection against a fall in stock price

Typical use: A investor whose view is that the market or stock price is going to go down, by the

agreed delivery date

Example:

A bearish investor cannot short in the ready market

However, in the futures market, the investor can short sell in the PTC future contract at

PkR47.50, i.e. PkR47, 500 for 5,000 shares at 20% margin

If the market price of PTC goes down by PkR1.5 in 1 months time (future settlement date), the

respective gain in the futures market would be PkR7,500 ignoring financial costs

Stock Index Futures Contracts:

Introduced in 1980 at NYSE

(This product has taken 28 years to reach the Pakistani market) Normally, index futures have

been introduced first in capital markets as against stock futures. Creates Link between Stock and

Futures Market. Increases Institutional Investor base. Within 2 years outnumbered cash Market

volumes at NYSE

KSE 30 Index Future exists - at least on KATS Screen:

The KSE is ‘writer’ / manager of this instrument.

The index future would be cash-settled and traded on the exchange. Standard contract is

of 30 60 or of 90-day duration.

Trading lot is marketable lot of 500 shares called ‘contracts’, with each contract being

‘valued’ theoretically at the KSE-30 index level. Thus if the KSE-30 index level is at

10,014, the price per contract should also be near Rs 10,014.

Typical use: A investor, who has a view on the market direction but not any specific

stock, can take a position on the ‘market’.

Options Contract:

An Option is a right, but not an obligation, to buy or sell, a specified amount of an underlying

asset, at an agreed upon price, on or before a specified date

The KSE has circulated for comments, draft rules pertaining to the introduction of ‘options’ on

individual stocks. However, so far no decisions have been made as regards the ‘option writers’.

Benefits of options:

Ability to take positions at other than current market levels

Options available in-the-money, at-the-money and out-of-the-money

Futures and forward contracts available only at current market (i.e. at-the money)

Leverage

Full participation in gains with small initial outlay

No margin required for buyers

Margin is required for writers

Futures contracts subject to margin requirement

Types of Options:

1. Call- Right to BUY a specified amount of underlying asset

2. Put- Right to SELL a specified amount of the underlying asset

Components of Option Contract:

Underlying Asset:

This is the asset which the Option Buyer has the right to buy or sell-Bonds, Foreign Exchange,

Futures Contracts

Strike Price or Exercise Price:

This is the price at which the underlying asset can be bought or sold

Premium:

This is the cost of the Option- the amount (fee) paid by the Option buyer to the Option seller

Time to Expiration or Maturity:

This is the amount of time remaining that the Option buyer has the right to exercise the option.

There are two types of options:

European Option- The Option buyer has the right to exercise only on the maturity date

American Option- The Option buyer has the right to exercise at any time on or before the

maturity date

Option Buying and Writing:

An option contract gives the buyer of the option the right to require the writer of the option to

perform according to the stated provisions of the contract

Buyer- Pays a fee, or premium, to obtain this right, and has a long position in the option

Writer (Seller) - Receives the premium in return for granting the option, and has a short position

in the option

Swaps:

Traditionally, the exchange of one security for another to change the maturity (bonds), quality of

issues (stocks or bonds), or because investment objectives have changed. Swaps have grown to

include currency swaps and interest rate swaps

Types of SWAPS transaction:

1. Pure Swap - Purchase and sale of the same currency for different value dates with the

same counter-party.

2. Engineered Swap - Purchase and sale of the same currency the different value dates but

with different counter-parties.

Interest Rate Swap:

An interest rate swap is a derivative in which one party exchanges a stream of interest

payments for another party's stream of cash flows. Interest rate swaps can be used by

hedgers to manage their fixed or floating assets and liabilities

They can also be used by speculators to replicate unfunded bond exposures to profit

from changes in interest rates.

Interest rate swaps are very popular and highly liquid instruments.

ISDA represents participant in the privately negotiated derivatives industry and is the

largest global financial trade association, by number of member firms.

Since its inception, ISDA has pioneered efforts to identify and reduce the sources of risk

in the derivatives and risk management business. Among its most notable

accomplishments are: developing the ISDA Master Agreement; publishing a wide range

of related documentation materials and instruments covering a variety of transaction

types; producing legal opinions on the enforceability of netting and collateral

arrangements (available only to ISDA members).

Interest rate Swap Structure:

In an interest rate swap, each counterparty agrees to pay either a fixed or floating rate

denominated in a particular currency to the other counterparty. The fixed or floating rate

is multiplied by a notional principal amount (say, USD 1 million). This notional amount

is generally not exchanged between counterparties, but is used only for calculating the

size of cash flows to be exchanged

The most common interest rate swap is one where one counterparty A pays a fixed rate

(the swap rate) to counterparty B, while receiving a floating rate (usually pegged to a

reference rate such as LIBOR)

A pays fixed rate to B (A receives variable rate)

B pays variable rate to A (B receives fixed rate)

Consider the following swap in which Party A agrees to pay Party B periodic

fixed interest rate payments of 3.00%, in exchange for periodic variable

Interest rate payments of LIBOR + 50 bps (0.50%). Note that there is no exchange of the

principal amounts and that the interest rates are on a "notional" (i.e. imaginary) principal

amount. Also note that the interest payments are settled in net (e.g. if LIBOR is 1.30%

then Party B receives 1.20% (3.00% - (LIBOR + 50 bps)) and Party A pays 1.20%). The

fixed rate (3.00% in this example) is referred to as the swap rate

At the point of initiation of the swap, the swap is priced so that it has a net present value

of zero. If one party wants to pay 50 bps above the par swap rate, the other party has to

pay approximately 50 bps over LIBOR to compensate for this.

Currency Swap:

A currency swaps (or cross currency swap) is a foreign exchange agreement between two parties

to exchange principal and fixed rate interest payments on a loan in one currency for principal and

fixed rate interest payments on an equal (regarding net present value) loan in another currency.

Currency swaps are motivated by comparative advantage

Unlike interest rate swaps, currency swaps involve the exchange of the principal amount.

Interest payments are not netted (as they are in interest rate swaps) because they are

denominated in different currencies

Credit Default Swap:

A credit default swap (CDS) is a credit derivative contract between two counterparties. The

buyer makes periodic payments to the seller, and in return receives a payoff of an underlying

financial instrument defaults.

CDS contracts have been compared with insurance, because the buyer pays a premium and, in

return, receive a sum of money if one of the specified events occurs

Does Pakistan Really Need Derivatives:

The advantage of the derivatives market is likely to be visible in the ongoing expansion

surge being witnessed in the country

A primary example is the cement industry which under the current phase of expansion

has seen notable names enter the derivatives market to facilitate expansion projects

Lucky Cement, Pakistan’s largest cement manufacturer has entered into a combination of

interest rate and currency swaps to finance its expansion projects. Under the current

interest rate swap the company receives a floating rate equivalent to 6-month T-Bill or

KIBOR in exchange for the fixed payment from 7% - 9.3%. Lucky is likely to benefit in

an environment which expects interest rates to increase

Attack Cement has also entered into an interest rate swap arrangement to finance its

expansion project. The company receives a fixed mark-up above a floating KIBOR rate

against fixed payments.