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Chapter#1 Chapter#1 Document Transcript

  • 1 CHAPTER#1 What is investment? The term of investing can cover a wide range of activities .It often refers to investing money in certificate of deposit, bonds, common stock or mutual funds. Most knowledgable investment would include other paper assets such as warrants, puts and calls, future contracts and convertibles securities as well as tangible assets. Investment encompasses very conservative positions as well as aggressive speculations. INVESTMENTS “The commitment of funds to one or more assets that will be held over some future time period.” The field of investments therefore involves the study of the investment process. Investments is concerned with the management of an investors wealth, which is the sum of current income and the present value of all future income. Although, the field of investments encompass many aspects , it can be thought of in terms of two primary functions such as Security analysis and Portfolio management. CHARACTERISTICS OF INVESTMENTS Certain features characterize all investments. The following are the main characteristics of investments: 1: RETURN All investments are characterized by the expectation of a return. In fact, investments are made with the primary objective of deriving a return. The return may be received in the form of yield plus capital appreciation. The difference between the purchase price and sale price is the capital appreciation. The dividend or interest received from the investment is the yield. Different types of investments promised different rates of return. The return from an investment depends upon the nature of investment, the maturity period and a host of other factors. 2: RISK Risk is inherent in any investment. The risk may relate to loss of capital, delay in repayment of capital and non-payment of interest or variability of returns. The risk of an investment depends on the following factors:
  • 2 1) The longer the maturity period, the longer is the risk. 2) The lower the credit worthiness of the borrower, the higher is the risk. The risk varies with the nature of investment. Investment in ownership securities like equities share carry higher risk compared to investment in debt instruments like bonds and debentures. 3:SAFETY The safety of an investment implies the certainty of return of capital without loss of money or time. Safety is another feature which an investor desires for his/her investments. Every investor expects to get back his capital on maturity without loss or delay. 4:LIQUIDITY An investment which is easily sellable or marketable without loss of money and time is said to possess liquidity. Some investment instruments like preference shares and debentures are marketable but there are not buyers in many cases and hence their liquidity is negligible. Equity shares of company listed on stock exchanges are easily marketable through stock exchanges. An investor generally prefers liquidity for his investment, safety of his fund and a good return with minimize risk and maximization of return. OBJECTIVES OF INVESTMENTS Different objectives of investment are as follows: 1: SAFETY Perhaps there is truth to the axiom that there is no thing such as completely safe and secure investment. Yet we can get close to ultimate safety for our investment funds through the purchase of government issued securities in stable economic systems or through the purchase of the highest quality corporate bonds issued by the economy top companies. Such securities are arguably the best means of preserving principal while receiving a specified rate of return. The safest investments are usually found in the money market ,which includes security such as T-bills, CDs, commercial papers etc or in the fixed income market in the form of municipal, government, and corporate bonds. 2: INCOME The safest investments are also the ones that are likely to have the lowest rate of income return or yield. Investors must inevitably sacrifice a degree of safety if they want to increase their yields. This is the inverse relationship between safety and yield as yield increases, safety generally goes down and vice versa. In order to increase their rate of investment return and take on risk above that of money market instruments or government bonds, investors may
  • 3 choose to purchase corporate bonds or preference shares with lower investment ratings. Investment grade bonds rated at A or AA are slightly riskier than AAA bonds , but presumably also offer a higher income return than AAA bonds. Mostly investors , even the most conservative-minded ones want some level of income generation in their portfolios, even if it just to keep up with the economy rate of inflation. 3: GROWTH OF CAPITAL Growth of capital is most closely associated with the purchase of common stock particularly growth securities, which offer low yield but considerable opportunity for increase in value. For this reason, common stock generally ranks among the most speculative of investments as their return depends on what will happen in an un-predictable future. Blue chip stocks by contrast can potentially offer the best of all world by possessing reasonable safety, modest income and potential for growth in capital generated by long term increase in corporate revenues and earnings as the company matures. 4: TAX MINIMIZATION An investor may pursue certain investments in order to adopt tax minimization as part of his investment strategy. A highly paid executives, for example, may want to seek investments with favourable tax treatment in order to lessen his overall income tax burden. Making contributions to an IRA or other tax-sheltered retirement plan such as a 401(K) can be an effective tax minimization strategy. 5: MARKETABILITY OR LIQUIDITY Many of the investments we have discussed are reasonably illiquid, which means they can not be immediately sold and easily converted into cash. Achieving a degree of liquidity, however, requires the sacrifice of a certain level of income or potential for capital gains. Common stock is often considered the most liquid of investments, since it can usually be sold within a day or two day of the decision to sell. Bonds can also be fairly marketable but some bonds are highly illiquid or non tradable possessing a fixed term. Similarly, money market instruments may only be redeemable at the precise date at which the fixed term ends. If investors seek liquidity, money market assets and non tradable bonds are not likely to held in portfolios. 6: CAPITAL PRESERVATION Capital preservation is a strategy you often associate with elderly people who want to make sure they do not outlive their money. Retired on nearly retired people often use this strategy to hold on the detention has. For this investor, safety is extremely important even to the extent of giving up return for security. The logic for this safety is clear. If they lose their money through foolish investment and are retired, it is unlikely they will get a chance to replace it. Investors who use capital preservation tend to invest in bank CDs. US Treasury issues, saving accounts.
  • 4 7: SPECULATION The speculation is not a true investor but a trader who enjoys jumping into or out of stocks as if they were bad shoes. Speculators or traders are interested in quick profits and used advanced tracking techniques like shorting stocks, trading on the margin, options and other special equipments. Speculators keep eyes open for a quick profit situation and hope to trade in and out without much thought about the underlying companies. Many people try speculating in the stock market with the misguided goal of getting rich. It does not work that way 8: TOTAL RETURN Total return is the need to grow the capital base through capital appreciation and reinvestment of that appreciation. IMPORTANCE OF INVESTMENTS If you are just starting out and beginning an investment program may be something that has not been on your rode. You may be more concerned with how to pay for items like food and gasoline. However, if you can scrap together even a small amount of money for investment purpose, you will be on your way to creating a much rosier financial picture in the years to come. The importance of investment with personal and professional aspects are as follows: A: THE PERSONAL ASPECTS It is important to remember that all individuals have wealth of some kind; if nothing else, this wealth may consist of the value of their services in the marketplace. Most individuals must make investment decisions sometime in their lives. For example, many employees today make investment decide whether their retirement funds are to be invested in stocks or bonds or some other alternative. And many people try to build some wealth during their working years by investing. 1: SAVINGS FOR RETIREMENT Depending solely on social security benefits as your source of retirement income probably would not cut it unless you plan to subsist on a diet of rice and water. Unless your company offers a sizable pension plan, you will probably need to start an investment program as early as possible to ensure a comfortable retirement. IRAs offer an easy way to invest for retirement and also provide certain tax benefits. If your employer offers a 401(K) plan, you can benefit from the matching funds that many companies will deposit in your account on your behalf.
  • 5 2: PUTTING YOUR MONEY TO WORK If you have a job, you are undoubtedly familiar with the concept of working for your money. Investing allows you to turn the tide by making your money work for you. Trough the magic of compound interest , for example, your accumulated interest actually earns additional money without you having to lift a finger. Consequently, your original investment can multiply greatly over time. 3: FINANCIAL RESOURCE Some investment can fulfill more than one financial purpose and serve as a valuable resource. For instance, when you purchase a home , it may appreciate in value and yield a handsome profit when you sell it. Additionally, as you make your monthly mortgage payments you build up equity, which is the amount of your ownership stake in the property. You can borrow against your accumulated equity by taking out a home equity loan or home equity line of credit to help you more immediate financial needs. 4: BEATING INFLATION In addition to making for uncomfortable sleeping, stuffing your money under a mattress does little to mitigate the impact of inflation over time. Putting your money in a regular bank savings account would not help much either because of the typically minuscule interest rates. While placing your money in investment vehicles, such as stocks and mutual funds, introduces an element of risk, you stand a much better chance of outpacing the inflation rate throughout a period of years. 5: INCREASES VISION Vision is not about to see the things happening but it is to see through the future happenings. For investing, you need a good vision into the future and should be able to interpret the futuristic phenomena of a company s perspective. So good vision fetches you more returns and will contribute to your success at all the fields. 6: INCREASES KNOWLEDGE As investment does not mean buying and selling only and it needs a through research in the various aspects of stock market and the company , it will improve your knowledge. It develops your knowledge in various fields. Learning more knowledge makes you to err seldom and which in turn make you a successful investor. 7: DESIRES FOR FAMILY MEMBERS It is your social responsibility towards your family members to look after them. It also includes to take care of their personal desires also. And you are the first responsible person to fulfill their wishes time to time. So if you invest carefully and get good returns and become rich
  • 6 by that you may easily fulfill all the desires of yourself as well as your family members also. So investment plays a vital role in satisfying your family members wishes. 8: FULFILLING PERSONAL GOALS If you have a desire for having a luxurious apartment and a luxurious car of your own, then it is obvious that these desires may be fulfilled by a planned investment and savings. As you invest more, you tend to become richer .And as you become richer , you may find no difficulty in achieving your personal goals is the essence of your success in every aspect of your life. 9: INCREASES WEALTH Besides making you financially independent, investment makes you rich also. As you invest more and more money for a long time, it will definitely make you more richer.In the presence generation, it is of utmost importance to be rich as it gives more benefits in each and every aspect of your life. So investment increases your returns and at the same time make you wealthy. As you become more wealthy, you will have more financial freedom and vice versa. So wealth is also an important factor of our lifestyle. 10: FINANCIAL INDEPENDENCE The most important thing is an investment gives you financial independence. If you invest your money from the beginning, you need not to worry about the future financial needs. As future is uncertain and there may be a situation in your life where you require a large amount of money to get out of that situation with minimal loss. So to effectively protect yourself from such type of situation you must include the habits of saving and investing. It may be because of your children s education, marriage and medication. Let it be anything which demands lot of money you may surpass it if you have invested. B: INVESTMENT AS A PROFESSION In addition to the above reasons, the world of investments offer several rewarding careers both professionally and financially. A study of investments in an essential part of becoming a professional in this field. 11: INVESTMENT BANKERS AND TRADERS In the course of selling of new securities, issuers often rely on an investment banker for the necessary expertise as well as the ability to reach widely dispersed suppliers of capital. Along with performing activities such as helping corporations in mergers and acquisitions, investment banking firms specialize in the design and sale of securities in the primary market while operating simultaneously in the secondary markets. Investment bankers act as intermediaries between issuers and investors. The issuers sell its securities to investment bankers, who turn sell the securities to the investors. 12: SECURITY ANALYSTS AND PORTFOLIO MANAGERS
  • 7 A range of financial institutions including brokerage firms and investment bankers as well as banks and insurance companies need the services of security analysts. Brokerage firm needs them to support their registered representatives who in turn serve the public. Investment bankers need analysts to assist in the sale of new securities and in the valuation of firms as possible merger or acquisition candidates. Banks and insurance companies own portfolio of securities that must be evaluated in order to be managed. Financial firms also need portfolio managers to manage the portfolio of securities handled by these organizations. Portfolio managers are responsible for making the actual buy and sell decisions. 13: STOCKBROKERS AND FINANCIAL ADVISERS Traditionally, brokerage firms offered a variety of services to the investors particularly information and advice. Brokerage firms consist of full service brokers and discount brokers . Today, investors can obtain a wide variety of information on the economy, particular industries, individual companies and the bond market from full service brokers . Brokers act as middleman matching clients with independent money managers. Finally, the number of financial advisers continues to grow. This area has employment opportunities for people interested in the investment field. These advisers must be registered with the Securities and Exchange Commission. 14: CFA DESIGNATION Individuals interested in the field opposed to financial planning, should consider studying to receive the “ CHARACTERED FINANCIAL ANALYST (CFA) DESIGNATION”. This is a professional designation for people in the investment areas. The CFA designation is widely recognized in the investment industry today. It serves as an indication that areas of knowledge relevant to investing have been studied and that high ethical and professional standards have been recognized in the field of investment.
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