The investment environment


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The investment environment

  1. 1. INVESTMENT ENVIRONMENT CHAPTER NO.1.WHAT IS INVESTMENT Investment has different meanings in finance and economics. In economics, investment is the accumulation of newly produced physical entities, such as factories, machinery, houses, and goods inventories. In finance, investment is putting money into an asset with the expectation of capital appreciation, dividends, and/or interest earnings. This may or may not be backed by research and analysis. Most or all forms of investment involve some form of risk, such as investment in equities, property, and even fixed interest securities which are subject, among other things, to inflation risk. In economic theory or in macroeconomics, non-residential fixed investment is the amount purchased per unit time of goods which are not consumed but are to be used for future production (i.e. capital). Examples include railroad or factory construction. Investment inhuman capital includes costs of additional schooling or on-the-job training. Inventory investment is the accumulation of goods inventories; it can be positive or negative, and it can be intended or unintended. In measures of national income and output, "gross investment" ( represented by the variable I ) is a component of gross domestic product (GDP), given in the formula GDP = C + I + G +NX, where C is consumption, G is government spending, and NX is net exports, given by the difference between the exports and imports, X − M. Thus investment is everything that remains of total expenditure after consumption, government spending, and net exports are subtracted (i.e. I = GDP − C − G − NX). Non-residential fixed investment (such as new factories) and residential investment (new houses) combine with inventory investment to make up I. "Net investment" Page 1
  2. 2. INVESTMENT ENVIRONMENT deducts depreciation from gross investment. Net fixed investment is the value of the net increase in the capital stock per year. Fixed investment, as expenditure over a period of time (e.g., "per year"), is not capital but rather leads to changes in the amount of capital. The time dimension of investment makes it a flow. By contrast, capital is a stock— that is, accumulated net investment to a point in time (such as December 31). Investment is often modeled as a function of income and interest rates, given by the relation I = f(Y, r). An increase in income encourages higher investment, whereas a higher interest rate may discourage investment as it becomes more costly to borrow money. Even if a firm chooses to use its own funds in an investment, the interest rate represents an opportunity cost of investing those funds rather than lending out that amount of money for interest. In finance, investment is the purchase of an asset or item with the hope that it will generate income or appreciate in the future and be sold at the higher price. It generally does not include deposits with a bank or similar institution. The term investment is usually used when referring to a long-term outlook. This is the opposite of trading or speculation, which are short-term practices involving a much higher degree of risk. Financial assets take many forms and can range from the ultra safe low return government bonds to much higher risk higher reward international stocks. A good investment strategy will diversify the portfolio according to the specified needs. The most famous and successful investor of all time is Warren Buffett. In March 2013 Forbes magazine had Warren Buffett ranked as number 2 in their Forbes 400 list. Buffett has advised in numerous articles and interviews that a good investment strategy is long term and choosing the right assets to invest in requires due diligence. Edward O. Thorp was a very successful hedge Page 2
  3. 3. INVESTMENT ENVIRONMENT fund manager in the 1970s and 1980s that spoke of a similar approach. Another thing they both have in common is a similar approach to managing investment money. No matter how successful the fundamental pick is, without a proper money management strategy, full potential of the asset can’t be reached. Both investors have been shown to use principles from the Kelly criterion for money management. Numerous interactive calculators which use the kelly criterion can be found online. In contrast, dollar (or pound etc.) cost averaging and market timing are phrases often used in marketing of collective investments and can be said to be associated with speculation. Investments are often made indirectly through intermediaries, such as pension funds, banks, brokers, and insurance companies. These institutions may pool money received from a large number of individuals into funds such as investment trusts, unit trusts, SICAVs etc. to make large scale investments. Each individual investor then has an indirect or direct claim on the assets purchased, subject to charges levied by the intermediary, which may be large and varied. It generally, does not include deposits with a bank or similar institution. Investment usually involves diversification of assets in order to avoid unnecessary and unproductive risk. Page 3
  4. 4. INVESTMENT ENVIRONMENT CHAPTER NO.2.TYPES OF INVESTMENT When you invest, you buy something that you expect will grow in value and provide a profit, either in the short term or over an extended period. You can choose among a vast universe of investment alternatives, from art to real estate. When it comes to financial investments, most people concentrate on three core categories: stocks, bonds, and cash equivalents. You can invest in these asset classes directly or through mutual funds and exchange-traded funds (ETFs). Many financial investments including stocks, bonds, and mutual funds and ETFs that invest in these assets are legally considered to be securities under the federal securities laws. Securities tend to be widely available, easily bought and sold, and subject to federal, state, and private-sector regulation. However, investing in securities carries certain risks. That’s because the value of your investment fluctuates as the market price of the security changes in response to investor demand. As a result, you can make money, but you can also lose some or all of your original investment.  Direct Investment: The purpose of a direct investment is to gain enough control of a company to exercise control over future decisions. This can be accomplished by gaining a majority interest or a significant minority interest. Direct investments can involve management participation, joint-venture or the sharing of technology and skills. The purchase or acquisition of a controlling interest in a foreign business by means other than the outright purchase of shares. Page 4
  5. 5. INVESTMENT ENVIRONMENT In domestic finance, the purchase or acquisition of a controlling interest or a smaller interest that would still permit active control of the company.  Indirect Investment: When there is an intermediary between the Investor and Investment that is indirect investment. The investor hand over his finances to the investment company that will invest the amount further and give him returns. (Usually an investment company does not invest in a single investment, rather divide that investment into smaller units and divide among investors that helps to reduce the risk.) It is on the discretion of the investment company where to invest the finances, the investor will get his agreed rate of return. An indirect investment is a type of investing opportunity that does not require the actual purchase of the asset that ultimately generates the return. This type of arrangement is often associated with investing in real estate ventures, typically by purchasing stocks issued by a real estate company that in turn purchases and maintains the properties generating the dividends issued to the shareholders. There are a number of benefits to indirect investment, including the ability to avoid having to be directly involved in the management and upkeep of the assets involved.  Equity Investment: The investment in the equity shares of a company is called equity investment. That can be in common stock or preferred stock. Investing in the stock market is a way of life in the United States, and most of these are equity investments. Even if a depositor in a bank or credit union has only a few hundred dollars in deposits, he or she is indirectly an equity investor through Page 5
  6. 6. INVESTMENT ENVIRONMENT the bank's stock portfolio. This is a long-term stock investment strategy whereby profits are realized through dividend payments and capital gains accrued on the equity of a particular stock. The great majority of equity investors do not actually hold the securities, or certificates. Instead, they have an account with a bank or a fund manager who has physical access to these stock certificates. Therefore, equity capital is money gained by a company in exchange for a share of ownership in the company. Equity investment is sort of a loan to the company that is paid back or not by way of dividends paid out of company profits or through the sale of ownership rights. The value of a property, less any debts owed on the property, is what’s known as equity. In the case of equity investment, the property is in the form of stock certificates and any debt is actually devaluation of the security. This devaluation may be incurred by a number of causes, from financial to foolish.  Debt Investment: The investment in bonds, loans, deposits and debentures is debt investment. A debt investment essentially is a loan given to companies or individuals to cover property or projects. Later, they pay you back, usually with interest. If the property or project is pledged as collateral for your loan (mortgaged), you may reclaim the property or project. Debt investment most often involves debt securities rather than debt equity. With debt security, you don't own the property or get profits. With debt equity, you actually have ownership of a portion of the company's assets. Page 6
  7. 7. INVESTMENT ENVIRONMENT Even when people make decent incomes, they typically want to find ways to ensure that money will be available for the future. The result is that many people, at one time or another, seek to invest their funds in order to gain a financial return. Often, a safe investment option is debt investment.  Derivative Securities Investment: Investment in paper assets such as options, futures, and contracts is known as derivative securities investment. There is a physical asset involved behind these investments. The value of investment is measured on the basis of underlying assets. A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros. Page 7
  8. 8. INVESTMENT ENVIRONMENT  High Risk Investment: The investment in securities like Futures, Junk Bonds or Speculative Bonds are considered high risk investments. The major risk is the Interest Rate Risk that cause variability in their value. Thus they provide high yield in compare to other securities. The chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviation indicates a high degree of risk. A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk that an investor is willing to take on, the greater the potential return. The reason for this is that investors need to be compensated for taking on additional risk.  Low Risk Investment: The investment in securities like Treasury Bills, Bonds and stocks are low risk investments thus yield low return as well.  Preferred Stock: Preferred stock is a hybrid security that trades like a stock but acts like a bond in many respects. It has a stated dividend rate that is usually around 2% higher than Page 8
  9. 9. INVESTMENT ENVIRONMENT what CDs or treasuries pay, and usually trades within a few dollars of the price at which it was issued (typically $25 per share). There are a few types of preferred stock: Cumulative Preferred. Accumulates any dividends that the issuing company cannot pay due to to financial problems. When the company is able to catch up on its obligations, then all past due dividends will be paid to shareholders. Participating Preferred. Allows shareholders to receive larger dividends if the company is doing well financially. Convertible Preferred. Can be converted into a certain number of shares of common stock.  Utility Stock: Like preferred stock, utility stocks tend to remain relatively stable in price, and pay dividends of about 2% to 3% above treasury securities. The other major characteristics of utility stocks include: Utility stocks are common stocks and come with voting rights. Their share prices are generally not as stable as preferred offerings. They are noncyclical stocks, which means that their prices do not rise and fall with economic expansion and contraction like some sectors, such as technology or entertainment. Because people and businesses always need gas, water, and electricity regardless of economic conditions, utilities are one of the most defensive sectors in the economy. Page 9
  10. 10. INVESTMENT ENVIRONMENT Utility stocks are also often graded by the ratings agencies in the same manner as bonds and preferred issues, are fully liquid like preferred stocks, and can be sold at any time without penalty. Utility stocks typically carry slightly higher market risk than preferred issues and are also subject to taxation on both dividends and any capital gains.  Fixed Annuities: Fixed annuities are designed for conservative retirement savers who seek higher yields with safety of principal. These instruments possess several unique features, including: They allow investors to put a virtually unlimited amount of money away and let it grow tax-deferred until retirement. The principal and interest in fixed contracts is backed by both the financial strength of the life insurance companies that issue them, as well as by state guaranty funds that reimburse investors who purchased an annuity contract from an insolvent carrier. Although there have been instances of investors who lost money in fixed annuities because the issuing company went bankrupt, the odds of this happening today are extremely low, especially if the contract is purchased from a financially sound carrier.  Short Term Investment: The investment in securities which are matured within a year is short term investment. An account in the current assets section of a company's balance sheet. This account contains any investments that a company has made that will expire within one Page 10
  11. 11. INVESTMENT ENVIRONMENT year. For the most part, these accounts contain stocks and bonds that can be liquidated fairly quickly. Most companies in a strong cash position have a short-term investments account on the balance sheet. This means that a company can afford to invest excess cash in stocks and bonds to earn higher interest than what would be earned from a normal savings account.  Long Term Investment: The investment in securities which have maturation life of over a year or have no limited maturity life like stocks is long term investment. An account on the asset side of a company's balance sheet that represents the investments that a company intends to hold for more than a year. They may include stocks, bonds, real estate and cash. The long-term investments account differs largely from the short-term investments account in that the short-term investments will most likely be sold, whereas the long-term investmen tmay never be sold. A common form of this type of investing occurs when company A invests largely in company B and gains significant influence over company B without having a majority of the voting shares. In this case, the purchase price would be shown as a long-term investment.  Domestic Investment: Investing within the premises of the country is called domestic investment. Page 11
  12. 12. INVESTMENT ENVIRONMENT  Foreign Investment: Whereas investment in foreign countries or either in foreign currency securities within own country is foreign investment. Flows of capital from one nation to another in exchange for significant ownership stakes in domestic companies or other domestic assets. Typically, foreign investment denotes that foreigners take a somewhat active role in management as a part of their investment. Foreign investment typically works both ways, especially between countries of relatively equal economic stature. Currently there is a trend toward globalization whereby large, multinational firms often have investments in a great variety of countries. Many see foreign investment in a country as a positive sign and as a source for future economic growth. The U.S. Commerce Department encourages foreign investment through its "Invest in America" initiative. Page 12
  13. 13. INVESTMENT ENVIRONMENT CHAPTER NO.3. INVESMENT ENVIRONMENT The field of study which involves the study of investment environment, investment process and investment securities and markets. Investment Environment:  Types of Securities: Investments are a great way to grow your money. They allow you to potentially have more money at retirement or for other investment goals than if you just put your earnings in a bank. There are many different securities that you can invest your money in. They're usually divided into two categories. Equity securities grant you partial ownership of a company. Debt securities are considered loans to companies or entities of the government. Here's a quick refresher on some of the most popular security investments. Stocks: Stocks are the best known equity security. You're purchasing an ownership interest in a company when you buy stock. You're entitled to a portion of company profits and sometimes shareholder voting rights. Stock prices can fluctuate greatly. Investors try to buy stock when the price is low and sell it when the price is high. Stock has a higher investment risk than most other securities. There's no guarantee that you won't lose money. However, stock usually has the potential for the greatest returns. Page 13
  14. 14. INVESTMENT ENVIRONMENT Most stock is considered common stock. Preferred stock normally offers dividends but not voting rights. Common stockholders also have greater potential for higher returns. Corporate Bonds: A corporate bond is a debt instrument issued by a company. It's a loan to the company when you invest in a bond. You're entitled to receive interest each year on the loan until it's paid off. Bonds are safer and more stable than stocks. You're guaranteed a steady income from bonds. However, bondholders aren't entitled to dividends or voting rights. In addition, stockholders have potential for greater returns in the long run. Government Bonds: Government bonds are issued by the US federal government. The most common are US Treasury bonds. They're issued to help finance the national debt. Government bonds have very low investment risk. In fact, they're virtually riskfree since they're guaranteed by the US government. However, the potential return is lower than stocks and corporate bonds. Municipal Bonds: Municipal bonds are debt securities from states and local government entities. These local entities include counties, cities, towns and school districts. The interest income you earn on the municipal bonds is usually exempt from federal income taxes. It may also be exempt from state and local income taxes if you live where Page 14
  15. 15. INVESTMENT ENVIRONMENT the bonds are issued. However, the interest rate is usually lower than corporate bonds. Mutual Funds: A mutual fund is made up of a variety of securities. It may focus on stocks, bonds or a collection of both. Your money is usually pooled with other investors. An investment company chooses the securities and manages the mutual fund. This diversity helps decrease investment risk. Stock Options: A stock option is the right to buy or sell a stock at a certain price for a period of time. A call is the right to buy the stock. A put is the right to sell the stock. Stock options can be used to help reduce your investment risk. Futures Options: A futures contract is an agreement to sell a specific commodity at a future date for an agreed upon price. A futures option is the right to buy or sell a futures contract at a certain price for a specific period of time. Many investors use futures options to help reduce investment risk.  Types of Financial markets: A financial market is a broad term describing any market place where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees, and market forces determining the prices of securities that trade. Page 15
  16. 16. INVESTMENT ENVIRONMENT Financial markets can be found in nearly every nation in the world. Some are very small, with only a few participants, while others - like the New York Stock Exchange (NYSE) and the forex markets - trade trillions of dollars daily. Investors have access to a large number of financial markets and exchanges representing a vast array of financial products. Some of these markets have always been open to private investors; others remained the exclusive domain of major international banks and financial professionals until the very end of the twentieth century. Capital Markets: A capital market is one in which individuals and institutions trade financial securities. Organizations and institutions in the public and private sectors also often sell securities on the capital markets in order to raise funds. Thus, this type of market is composed of both the primary and secondary markets. Any government or corporation requires capital (funds) to finance its operations and to engage in its own long-term investments. To do this, a company raises money through the sale of securities - stocks and bonds in the company's name. These are bought and sold in the capital market. Stock markets: Stock markets allow investors to buy and sell shares in publicly traded companies. They are one of the most vital areas of a market economy as they provide companies with access to capital and investors with a slice of ownership in the company and the potential of gains based on the company’s future performance. Page 16
  17. 17. INVESTMENT ENVIRONMENT This market can be split into two main sections: the primary market and the secondary market. The primary market is where new issues are first offered, with any subsequent trading going on in the secondary market. Bond Markets: A bond is a debt investment in which an investor loans money to an entity (corporate or governmental), which borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities. Bonds can be bought and sold by investors on credit markets around the world. This market is alternatively referred to as the debt, credit or fixed-income market. It is much larger in nominal terms that the world's stock markets. The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as simply "Treasuries." Money Market: The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. Money market securities consist of negotiable certificates of deposit (CDs), banker's acceptances, U.S. Treasury bills, commercial paper, municipal notes, eurodollars, federal funds and repurchase agreements (repos). Money market investments are also called cash investments because of their short maturities. The money market is used by a wide array of participants, from a company raising money by selling commercial paper into the market to an investor purchasing CDs as a safe place to park money in the short term. The money market is typically seen Page 17
  18. 18. INVESTMENT ENVIRONMENT as a safe place to put money due the highly liquid nature of the securities and short maturities. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities. However, there are risks in the money market that any investor needs to be aware of, including the risk of default on securities such as commercial paper. Cash or Spot Market: Investing in the cash or "spot" market is highly sophisticated, with opportunities for both big losses and big gains. In the cash market, goods are sold for cash and are delivered immediately. By the same token, contracts bought and sold on the spot market are immediately effective. Prices are settled in cash "on the spot" at current market prices. This is notably different from other markets, in which trades are determined at forward prices. The cash market is complex and delicate, and generally not suitable for inexperienced traders. The cash markets tend to be dominated by so-called institutional market players such as hedge funds, limited partnerships and corporate investors. The very nature of the products traded requires access to far-reaching, detailed information and a high level of macroeconomic analysis and trading skills. Derivatives Markets: The derivative is named so for a reason: its value is derived from its underlying asset or assets. A derivative is a contract, but in this case the contract price is determined by the market price of the core asset. If that sounds complicated, it's because it is. The derivatives market adds yet another layer of complexity and is therefore not ideal for inexperienced traders looking to speculate. However, it can be used quite effectively as part of a risk management program. Page 18
  19. 19. INVESTMENT ENVIRONMENT Examples of common derivatives are: forwards, futures, options, swaps and contracts-for-difference(CFDs). Not only are these instruments complex but so too are the strategies deployed by this market's participants. There are also many derivatives, structured products and collateralized obligations available, mainly in the over-the-counter (non-exchange) market, that professional investors, institutions and hedge fund managers use to varying degrees but that play an insignificant role in private investing. Forex and the Interbank Market: The interbank market is the financial system and trading of currencies among banks and financial institutions, excluding retail investors and smaller trading parties. While some interbank trading is performed by banks on behalf of large customers, most interbank trading takes place from the banks' own accounts. The forex market is where currencies are traded. The forex market is the largest, most liquid market in the world with an average traded value that exceeds $1.9 trillion per day and includes all of the currencies in the world. The forex is the largest market in the world in terms of the total cash value traded, and any person, firm or country may participate in this market. There is no central marketplace for currency exchange; trade is conducted over the counter. The forex market is open 24 hours a day, five days a week and currencies are traded worldwide among the major financial centers of London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris and Sydney. Until recently, forex trading in the currency market had largely been the domain of large financial institutions, corporations, central banks, hedge funds and extremely wealthy individuals. The emergence of the internet has changed all of this, and Page 19
  20. 20. INVESTMENT ENVIRONMENT now it is possible for average investors to buy and sell currencies easily with the click of a mouse through online brokerage accounts. Primary Markets vs. Secondary Markets: A primary market issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Primary markets, also known as "new issue markets," are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee its sale directly to investors. The primary markets are where investors have their first chance to participate in a new security issuance. The issuing company or group receives cash proceeds from the sale, which is then used to fund operations or expand the business. The secondary market is where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The Securities and Exchange Commission (SEC) registers securities prior to their primary issuance, then they start trading in the secondary market on the New York Stock Exchange, Nasdaq or other venue where the securities have been accepted for listing and trading. The secondary market is where the bulk of exchange trading occurs each day. Primary markets can see increased volatility over secondary markets because it is difficult to accurately gauge investor demand for a new security until several days of trading have occurred. In the primary market, prices are often set beforehand, whereas in the secondary market only basic forces like supply and demand determine the price of the security. Page 20
  21. 21. INVESTMENT ENVIRONMENT Secondary markets exist for other securities as well, such as when funds, investment banks or entities such as Fannie Mae purchase mortgages from issuing lenders. In any secondary market trade, the cash proceeds go to an investor rather than to the underlying company/entity directly. The OTC Market: The over-the-counter (OTC) market is a type of secondary market also referred to as a dealer market. The term "over-the-counter" refers to stocks that are not trading on a stock exchange such as the Nasdaq, NYSE or American Stock Exchange (AMEX). This generally means that the stock trades either on the overthe-counter bulletin board (OTCBB) or the pink sheets. Neither of these networks is an exchange; in fact, they describe themselves as providers of pricing information for securities. OTCBB and pink sheet companies have far fewer regulations to comply with than those that trade shares on a stock exchange. Most securities that trade this way are penny stocks or are from very small companies. Third and Fourth Markets: You might also hear the terms "third" and "fourth markets." These don't concern individual investors because they involve significant volumes of shares to be transacted per trade. These markets deal with transactions between brokerdealers and large institutions through over-the-counter electronic networks. The third market comprises OTC transactions between broker-dealers and large institutions. The fourth market is made up of transactions that take place between large institutions. The main reason these third and fourth market transactions occur is to avoid placing these orders through the main exchange, which could greatly affect the price of the security. Because access to the third and fourth markets is limited, their activities have little effect on the average investor. Page 21
  22. 22. INVESTMENT ENVIRONMENT Financial institutions and financial markets help firms raise money. They can do this by taking out a loan from a bank and repaying it with interest, issuing bonds to borrow money from investors that will be repaid at a fixed interest rate, or offering investors partial ownership in the company and a claim on its residual cash flows in the form of stock.  Types of Investment Companies:  Unit Investment Trusts (UITs) A unit investment trust, or UIT, is a company established under an indenture or similar agreement. It has the following characteristics: The management of the trust is supervised by a trustee. Unit investment trusts sell a fixed number of shares to unit holders, who receive a proportionate share of net income from the underlying trust. The UIT security is redeemable and represents an undivided interest in a specific portfolio of securities. The portfolio is merely supervised, not managed, as it remains fixed for the life of the trust. In other words, there is no day-to-day management of the portfolio.  Face Amount Certificates: A face amount certificate company issues debt certificates at a predetermined rate of interest. Additional characteristics include: Certificate holders may redeem their certificates for a fixed amount on a specified date, or for a specific surrender value, before maturity. Page 22
  23. 23. INVESTMENT ENVIRONMENT Certificates can be purchased either in periodic installments or all at once with a lump-sum payment. Face amount certificate companies are almost nonexistent today.  Management Investment Companies: The most common type of investment company is the management investment company, which actively manages a portfolio of securities to achieve its investment objective. There are two types of management investment company: closed-end and open-end. The primary differences between the two come down to where investors buy and sell their shares in the primary or secondary markets and the type of securities they sell. Closed-End Investment Companies: A closed-end investment company issues shares in a one-time public offering. It does not continually offer new shares, nor does it redeem its shares like an open-end investment company. Once shares are issued, an investor may purchase them on the open market and sell them in the same way. The market value of the closed-end fund's shares will be based on supply and demand, much like other securities. Instead of selling at net asset value, the shares can sell at a premium or at a discount to the net asset value. Open-End Investment Companies: Open-end investment companies, also known as mutual funds, continuously issue new shares. These shares may only be purchased from the investment company and sold back to the investment company. Mutual funds are discussed in more detail in the Variable Contracts section. Page 23
  24. 24. INVESTMENT ENVIRONMENT CHAPTER NO.4.INVESTMENT MANAGEMENT PROCESS Investment management process is the process of managing money or funds. The investment management process describes how an investor should go about making decisions. Investment management process can be disclosed by five-step procedure, which includes following stages: 1. Setting of investment policy. 2. Analysis and evaluation of investment vehicles. 3. Formation of diversified investment portfolio. 4. Portfolio revision 5. Measurement and evaluation of portfolio performance. Setting of investment policy: is the first and very important step in investment management process. Investment policy includes setting of investment objectives. The investment policy should have the specific objectives regarding the investment return requirement and risk tolerance of the investor. For example, the investment policy may define that the target of the investment average return should be 15 % and should avoid more than 10 % losses. Identifying investor’s tolerance for risk is the most important objective, because it is obvious that every investor would like to earn the highest return possible. But because there is a positive relationship between risk and return, it is not appropriate for an investor to set his/ her Page 24
  25. 25. INVESTMENT ENVIRONMENT investment objectives as just ―to make a lot of money‖. Investment objectives should be stated in terms of both risk and return. The investment policy should also state other important constrains which could influence the investment management. Constrains can include any liquidity needs for the investor, projected investment horizon, as well as other unique needs and preferences of investor. The investment horizon is the period of time for investments. Projected time horizon may be short, long or even indefinite. Setting of investment objectives for individual investors is based on the assessment of their current and future financial objectives. The required rate of return for investment depends on what sum today can be invested and how much investor needs to have at the end of the investment horizon. Wishing to earn higher income on his / her investments investor must assess the level of risk he /she should take and to decide if it is relevant for him or not. The investment policy can include the tax status of the investor. This stage of investment management concludes with the identification of the potential categories of financial assets for inclusion in the investment portfolio. The identification of the potential categories is based on the investment objectives, amount of investable funds, investment horizon and tax status of the investor. we could see that various financial assets by nature may be more or less risky and in general their ability to earn returns differs from one type to the other. As an example, for the investor with low tolerance of risk common stock will be not appropriate type of investment. Analysis and evaluation of investment vehicles: When the investment policy is set up, investor’s objectives defined and the potential categories of financial assets for inclusion in the investment portfolio identified, the available investment types can Page 25
  26. 26. INVESTMENT ENVIRONMENT be analyzed. This step involves examining several relevant types of investment vehicles and the individual vehicles inside these groups. For example, if the common stock was identified as investment vehicle relevant for investor, the analysis will be concentrated to the common stock as an investment. The one purpose of such analysis and evaluation is to identify those investment vehicles that currently appear to be mispriced. There are many different approaches how to make such analysis. Most frequently two forms of analysis are used: technical analysis and fundamental analysis. Technical analysis involves the analysis of market prices in an attempt to predict future price movements for the particular financial asset traded on the market. This analysis examines the trends of historical prices and is based on the assumption that these trends or patterns repeat themselves in the future. Fundamental analysis in its simplest form is focused on the evaluation of intrinsic value of the financial asset. This valuation is based on the assumption that intrinsic value is the present value of future flows from particular investment. By comparison of the intrinsic value and market value of the financial assets those which are under priced or overpriced can be identified. This step involves identifying those specific financial assets in which to invest and determining the proportions of these financial assets in the investment portfolio. Formation of diversified investment portfolio is the next step in investment management process. Investment portfolio is the set of investment vehicles, formed by the investor seeking to realize its’ defined investment objectives. In the stage of portfolio formation the issues of selectivity, timing and diversification need to be addressed by the investor. Selectivity refers to micro forecasting and focuses on forecasting price movements of individual assets. Timing involves Page 26
  27. 27. INVESTMENT ENVIRONMENT macro forecasting of price movements of particular type of financial asset relative to fixed-income securities in general. Diversification involves forming the investor’s portfolio for decreasing or limiting risk of investment. 2 techniques of diversification: random diversification, when several available financial assets are put to the portfolio at random; objective diversification when financial assets are selected to the portfolio following investment objectives and using appropriate techniques for analysis and evaluation of each financial asset. Investment management theory is focused on issues of objective portfolio diversification and professional investors follow settled investment objectives then constructing and managing their portfolios. Portfolio revision: This step of the investment management process concernsthe periodic revision of the three previous stages. This is necessary, because over time investor with long-term investment horizon may change his / her investment objectives and this, in turn means that currently held investor’s portfolio may no longer be optimal and even contradict with the new settled investment objectives. Investor should form the new portfolio by selling some assets in his portfolio and buying the others that are not currently held. It could be the other reasons for revising a given portfolio: over time the prices of the assets change, meaning that some assets that were attractive at one time may be no longer be so. Thus investor should sell one asset ant buy the other more attractive in this time according to his/ her evaluation. The decisions to perform changes in revising portfolio depend, upon other things, in the transaction costs incurred in making these changes. For Page 27
  28. 28. INVESTMENT ENVIRONMENT institutional investors portfolio revision is continuing and very important part of their activity. But individual investor managing portfolio must perform portfolio revision periodically as well. Periodic re-evaluation of the investment objectives and portfolios based on them is necessary, because financial markets change, tax laws and security regulations change, and other events alter stated investment goals. Measurement and evaluation of portfolio performance: This the last step ininvestment management process involves determining periodically how the portfolio performed, in terms of not only the return earned, but also the risk of the portfolio. For evaluation of portfolio performance appropriate measures of return and risk and benchmarks are needed. A benchmark is the performance of predetermined set of assets, obtained for comparison purposes. The benchmark may be a popular index of appropriate assets – stock index, bond index. The benchmarks are widely used by institutional investors evaluating the performance of their portfolios. It is important to point out that investment management process is continuing process influenced by changes in investment environment and changes in investor’s attitudes as well. Market globalization offers investors new possibilities, but at the same time investment management become more and more complicated with growing uncertainty. Page 28
  29. 29. INVESTMENT ENVIRONMENT CHAPTER NO.5. INVESTMENT SECURITIES Types of securities: Debt securities - are securities that give their holder the right to receive fixed interest rates (income) and transferred to a refund in the amount of debt, carried out by a certain date. In Russia, the debt securities are dennymi: Treasuries of the State; savings certificates; bills; bonds. Treasury of the state - a kind of securities placed by the state. Buying Treasury Bill, the owner is making money in the budget of the state in exchange for it, for the duration of ownership of treasury bills, receives a fixed income, and at the end of this term gets invested amount back. Savings certificates - a written certificate issued by the lending institution, the deposit of funds. Their investor is entitled to receive the deposit and interest thereon, but only when the term of the certificate of ownership comes to an end. Certificates may be bearer or registered shares. Promissory note - a written promissory note completed by a strict form prescribed by the exchange. It gives the owner (note holder) an exclusive right upon the expiration of the obligation to demand from the drawer (the debtor) the payment of a sum of money specified in the bill. Bonds - a kind of debt securities, which is the obligation of the issuer (the company that issued bonds) to return to the creditor (owner of the securities), the nominal value of its bonds as soon as the end in a timely manner. Also, the obligation of the issuer is a periodic payment to the creditor interest. Page 29
  30. 30. INVESTMENT ENVIRONMENT CHAPTER NO.6.CONCLUSION As you can see, international investment, like many aspects of globalization, presents opportunities as well as challenges. You may wonder where the balance of costs and benefits lies. The question is particularly acute for developing countries: many of the greatest controversies about financial liberalization covered in this issue brief are raised when investment flows from developed to developing countries. To be sure, many of the problems of developing countries stem from internal deficiencies, ranging from the inadequate supervision of the banking sector to corruption or inadequate labor and environmental standards. Understand the term investment and factors used to differentiate types of investments. Describe the investment process and types of investors. Discuss the principal types of investment vehicles. Describe the steps in investing and review fundamental personal tax considerations. Discuss investing over the life cycle and in different economic environments. Understand the popular types of short-term investment vehicles. Page 30
  31. 31. INVESTMENT ENVIRONMENT CHAPTER NO.7.REFERENCE BIBLIOGRAPHY:  Investment Management, Himalaya Publishing House. -Avadhani, V.A  Investment Management, Himalaya Publishing House. -Preeti Singh. WEBSITES:   Page 31