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).
include railroad or factory construction.
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"
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
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
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
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
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
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.
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.
In domestic finance, the purchase or acquisition of a controlling interest or a
smaller interest that would still permit active control of the company.
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
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
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.
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.
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.
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
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 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
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
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
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.
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 are designed for conservative retirement savers who seek higher
yields with safety of principal. These instruments possess several unique features,
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
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
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
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
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
Investing within the premises of the country is called domestic 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
CHAPTER NO.3. INVESMENT ENVIRONMENT
The field of study which involves the study of investment environment, investment
process and investment securities and markets.
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
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.
Most stock is considered common stock. Preferred stock normally offers dividends
but not voting rights. Common stockholders also have greater potential for higher
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 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 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
the bonds are issued. However, the interest rate is usually lower than corporate
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.
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.
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.
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
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
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 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.
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.
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."
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
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.
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.
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
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
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
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.
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.
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
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.
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.
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
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
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
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
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
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
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
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.
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.
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