Engineering the Zim financial market

financial sector on the brink of collapse. This recovery presents a gate of opportunities for investors while financial engineering could be used to solve some of the much headlined problems in our economy (i.e. those brought about by dollari­sation and any other factors).
Derivatives
The capital market in Zimbabwe is now characterised by liquidity problems and is highly volatile. This clips the wings of small investors to participate in the markets because of resultant higher transaction costs. Introduction of equity-based derivative con­tracts such as stock options and stock futures on the Zimbabwe Stock Exchange can widen the investor base of the stock market while providing more risk management tools for portfolio managers and investors.
Derivatives are legal agreements between two parties to trade an underlying asset at a date in the future. With stock index futures, the asset is a notional portfolio of shares as represented by a particular index and the cash amount on settlement is determined by the difference between the future price, that the investor agreed, and the index value on the day of settlement.
With stock options the holder of the option is not obliged to trade hence the name “option”, while the other party (the “writer”) is obliged to trade if the holder of the option wants to. For example, Air Zimbabwe might buy an option on a new aeroplane from Boe­ing.
This would give Air Zimbabwe the right to order the aeroplane at a specified price. The contract would not be legally binding on Air Zimbabwe (but it would be legally binding on Boeing). Air Zimbabwe would pay Boeing a small premium for this option.
The main objective of financial engineer­ing is to lower transaction costs and achieve better returns for investors.
Fixed Income
On the fixed income front there is much room for a variety of new debt instruments to be structured in order to raise much needed capital for the industry.
Terms of the debt contracts can be tailor-made in a way that fully captures the unique characteristics of each company such as their creditworthiness and the diversity of their income stream.
Several struggling parastatals can also be revived back to their feet again by use of financial engineering, for example Air Nige­ria which had far-reaching problems to our own Air Zimbabwe was recently bailed out using financial engineering.
This mainly involved debt and lease struc­turing and innovative crafting of contracts to gather funding.
Infrastructure
The infrastructure needs of Zimbabwe also present significant opportunity for investors. The need to improve on road infrastructure countrywide means that investors can put their money into lucrative long-term capital investments that are less volatile than tradi­tional stock markets.
With news of a US$1,3 billion round of power generation tenders, this leaves more room available for more power generation projects in wake of massive power shortages.
Electricity for all can be the only solution to current woes facing Zesa since the capital costs will be spread over a very large pool of customers and electricity become cheaper for households resulting in lesser defaults. Struc­tured infrastructure bills with attractive terms for the investors can be used to facili­tate such investment activity with the dollari­sation variable being taken into considera­tion (i.e. the downside/upside currency risk if Z$ is brought back during term of the bills).
This means companies can make dis­counted contracts with, say the power com­pany for supply of electricity through these bills. For example, several companies could release some electricity bills open to the gen­eral pool of investors. The funds raised are all forwarded to Zesa for electricity payment in advance through some contract. As a social responsibility part of the contract Zesa is then supposed to reduce tariff on house­holds. This can work if more companies buy the idea.
The property market has traditionally been a source of long-term capital appreciation for investors in Zimbabwe. A significant chal­lenge has been the lack of liquidity that char­acterises property investments and the inac­cessibility of such investments to small investors mostly due to the large capital out­lay required. A significant opportunity exists with regard to the establishment of real estate investment trusts (REITs) which are pooled investment vehicles that invest in a portfolio of properties.
Investors purchase units whose value is derived from the underlying property invest­ments and entitles them to a share of rental income and any proceeds from the sale of properties in the portfolio.
This affords the investor an opportunity to enter and exit the property investment mar­ket without the challenges of liquidity and capital.
There is great scope of innovation within this asset securitisation sphere as investors can gain access to instruments such as mort­gage-backed securities (MBS) which securi­tise pools of mortgages.
Private equity
Private equity investments seem to be on an upward trend in most emerging markets and Zimbabwe cannot be an exception. LET FINANCE BE ENGINEERED!

l Thomas Muserepwa is a Financial Engineering student at the Harare Institute of Technology and president of the Financial Engineering Society (FES). He is currently attached at GMRI Capital.