2. Meaning of investment
• Investment is foregoing the present consumption
in expectation of having greater consumption
opportunities in the future.
• It is current commitment of Birr for a period of time
in order to derive future payments that will
compensate the investor for
–(1) the time the funds are committed,
–(2) the expected rate of inflation, and
–(3) the uncertainty of the future payments.
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3. Investors can be individual investors; or Institutional investors.
Individual investors are those investors who are investing on
their own.
Sometimes individual investors are called retail investors.
Institutional investors are entities such as investment
companies, commercial banks, insurance companies, pension
funds and other financial institutions.
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4. Reasons for Investing: (Why people invest?)
Income: Some people invest in order to provide or supplement
their income. Investments provide income through the payment
of dividends or interest.
Appreciation: Other individuals, especially those in their peak
working years, may be more interested in seeing the value of
their investments grow rather than in receiving any income
from investment.
Appreciation is an increase in the value of an
investment.
Excitement: Investing is frequently someone’s hobby.
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5. Investment Goals
Enhancing current income: means choosing investment
vehicles that regularly pay dividends and interest that can
provide all or some of the money needed to meet living
expenses.
Saving for major expenditures includes money set aside for
such things as the down payment on a home, college tuition,
and even an expensive vacation.
Accumulate retirement funds: it is the single most important
reason for investing.
Sheltering income from taxes involves taking advantage of
certain tax provisions that permit reduction of the income
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6. Steps to Investment
• The seven steps in investing are as follows:
1. Meeting Investment Prerequisites: Providing for necessities
of life, adequate protection against losses, and setting
retirement goals.
2. Establishing Investment Goals: Investment goals are the
financial objectives that one wishes to achieve by investing
mentioned above.
3. Adopting an Investment Plan: An investment plan is a
written document describing how funds will be invested.
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7. 4. Evaluating Investment Vehicles: In this step, the measures
of risk and return are used to estimate the perceived worth of
an investment vehicle. This process is called valuation.
5. Selecting Suitable Investments: This step involves careful
selection of investment vehicles that are consistent with
established goals & offer acceptable levels of return, risk, &
value.
6. Constructing a Diversified Portfolio: Diversification is the
concept of forming a portfolio using different investment
vehicles to reduce risk and increase return.
7. Managing the Portfolio: Portfolio management involves
monitoring the portfolio and restructuring it as dictated by the
actual behavior of the investments.
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8. Investment Constraints
Financial Constraints: refer to whether an investor can
allocate some portion of savings for investment activities.
Psychological Constraints: refers to how well an investor can
absorb the consequences of an investment decision.
Management Constraint: refers to the lack of expertise in
managing the investment activities.
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9. Investment, Speculation and gambling
compared
• Investment: Foregoing the present consumption
in expectation of having greater consumption
opportunities in the future.
• Speculation: Aim high ‘gain or heavy loss; Higher
level of risk and more uncertain expected returns.
• Gambling: Gambling at 'out of proportion gain or
total loss.' Depend more on luck and chances.
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10. Investment Speculation
1. Risk and Return
Good return for an appropriate level of risk Willing to take high risk in exchange for a high return
2. Time Horizon
Longer period of time. At least 1 year Short period of time. Few days, weeks or months.
3. Performance
Interested in a company with a consistent
performance
Interested in a less consistent performance along with
some abnormal and extremely return on risk.
4. Motivation
Concerned with dividend payments & long
term growth prospect
Concerned with rapid short term price appreciation.
5. Decisions and Funds to buy
Careful & thorough fundamental analysis in
terms of past performance and future prospects.
Normally use their own money to buy
securities
Speculators will buy securities using borrowed funds
and choose securities mostly based on intuition and
rumors spread in the market.
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11. Investment Gambling
1. Purpose
A way of earning an income Is a form of entertainment
2. Time Horizon
Long period of time. At least 1 year Short period of time
3. Need for Analysis
Rely on careful analysis of the
market to reduce the risk
Depends on luck
4. Risk and Return
Have risk but on average the
return is positive.
Gambling has high risk and the
players’ return on average is negative
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12. Investment environment
• It is the existing investment vehicles in the market available for
investor and the places for transactions with these investment
vehicles.
• Investment vehicles: is an investment product that is offered to
investors that provide the chance for investors to earn a return, or
profit, on the product purchased.
• The main types of financial investment vehicles are:
– Short term investment vehicles;
– Fixed-income securities;
– Common stock;
– Speculative investment vehicles
– Other investment tools
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13. 1. Short - term investment vehicles
– They have a maturity of one year or less.
– They are often defined as money-market instruments
The main short term investment vehicles are:
Certificate of deposit is debt instrument issued by bank that indicates a specified
sum of money has been deposited at the depository institution.
Treasury bills (T-bills) are securities representing financial obligations of the
government. They have maturities of less than one year.
Commercial paper is a name for short-term unsecured promissory notes issued by
corporation. It is a means of short-term borrowing by large corporations.
Bankers acceptances are the vehicles created to facilitate commercial trade
transactions. A bank accepts the responsibility to repay a loan to the holder of the
vehicle in case the debtor fails to perform.
Repurchase agreement (often referred to as a repo) is the sale of security with a
commitment by the seller to buy the security back from the purchaser at a specified
price at a designated future date. 13
14. 2. Fixed-income securities
• Are those which return is fixed, up to some redemption date or
indefinitely. This type of financial investments is presented by
two different groups of securities:
• Long-term debt securities can be described as long-term debt
instruments representing the issuer’s contractual obligation. Long
term securities have maturity longer than 1 year.
• Preferred stocks are equity security, which has infinitive life
and pay dividends. But preferred stock is attributed to the type
of fixed-income securities, because the dividend for preferred
stock is fixed in amount and known in advance.
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15. 3. The common stock
• Represents the ownership interest of corporations or the equity
of the stock holders.
4. Speculative investment vehicles
• It is an investments with a high risk and high investment return.
• The only gain from such investments is the positive difference
between selling and purchasing prices.
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16. Financial markets
They are the other important component of investment
environment. In financial markets funds are channeled from
those with the surplus, who buy securities, to those, with
shortage, who issue new securities or sell existing securities.
Investment companies
Investment companies pool funds from various investors and
invest the accumulated funds in various financial instruments or
other assets. The profits and losses from the investment (after
repaying the management expenses) are distributed to the
investors in the funds in proportion to the investment amount.
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17. Functions of investment companies
• Record keeping and administration. Investment companies issue
periodic status reports.
• Diversification and divisibility. By pooling their money,
investment companies enable investors to hold fractional shares of
many different securities. They can act as large investors even if
any individual shareholder cannot.
• Professional management. Most, but not all, investment
companies have full-time staffs of security analysts and portfolio
managers who attempt to achieve superior investment results for
their investors.
• Lower transaction costs. Because they trade large blocks of
securities, investment companies can achieve substantial savings
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18. There are two types of investment companies/Investment funds:
• Open-End Funds: Have no pre-determined amount of stocks
outstanding and they can buy back or issue new shares at any
point. Price of the share is not determined by demand, but by
an estimate of the current market value of the fund’s net assets
value (NAV) and a commission.
• Closed-End Funds: Are publicly traded investment companies
that have issued a specified number of shares and can only
issue additional shares through a new public issue.
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