Question 4 (20 marks)

(a) The Hong Kong government became an active market participant which bought about US$15 billion shares of companies trading on the Hang Seng Index in August 1998 in the face of the Asian economic crisis. Discuss the pros and cons of its actions. (10 marks)

(b) Discuss the major risks of buying Exchange Traded Funds (ETF). (5 marks)

(c) What are the major challenges in developing ETF products in Hong Kong?

(5 marks)

(A) The pros of its actions are:

1. An exchange traded fund can give access to a group of market segments or sectors, which can be monitored or traced.

2. Exchange traded funds are of low cost.

3. An exchange traded fund comprises baskets of stocks and securities.

4. It gives exposure to various market styles and different classes of equities.

5. Exchange traded funds trade at a cost that is not static. A price that is updated all day long.

6. The Hong Kong government can trade options and futures, just like a stock.

(B) The major risks of buying exchange traded funds are:

1. The risks involved in trading

Since an exchange traded fund can be bought and sold like a stock, investment gain/return can be at risk. The costs of regular trading can exceed the benefit of purchasing exchange traded funds at low fees.

2. Taxation risk

Since exchange traded funds come with great tax efficiency, the risk of having to pay tax on your exchange traded fund is present.

3. Risks involved in portfolio

There are various specialty exchange traded funds. An individual or a country's portfolio is hereby susceptible to

- business risk

- liquidity risk

- political risk

- market risk, etcetera.

Each country fund the trader acquires, comes with its own liquidity and political risks because it's stability largely depends on the stability of the country's economy or political leadership!