Unit Isapm

8/17/2019 Unit Isapm

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INVESTMENT

Investment is an activity that is engaged in by people who have savings, i.e., investments are made from

savings, or in other words, people invest their savings. But all savers are not investors. Investment is an activity

which is different from saving. Investment is the employment of funds with the aim of achieving additional

income or growth in value. Investment has two attributed namely time and risk. Present consumption is

sacrificed to get a return in the future. The sacrifice that has to be borne is certain but the return in the future may

be uncertain. This attribute of investment indicates the risk factor. The risk is undertaken with a view to reap

some return for the investment.

FINANCIAL AND ECONOMIC MEANING OF INVESTMENT

Investment is the allocation of monetary resources to assets that are expected to yield some gain or

positive return over a given period of time. These assets range from safe investments to risky investments in this

form are also called ‘inancial Investments!.

In the economic sense, investment means the net additions to the economy!s capital stock which consists

of goods and services that are used in the production of other goods and services. Investment in this sense

implied the formation of new and productive capital in the form of new constructions, plant and machinery,

inventories etc., such investments generate physical assets.

The two types of investments are, however, related and dependent. The money invested in financial

investments are ultimately converted into physical assets. Thus, all investments result in the ac"uisition of some

assets either financial or physical.

CHARACTERISTICS OF INVESTMENT

#ll the investments are characteri$ed by certain features. The following characteristic features of

investment%

Return: #ll investments are characteri$ed by the expectation of a return. In fact, investments are made with the

primary ob&ective of deriving a return. The return may be received in the form of yield plus capital appreciation.

The difference between the sale price and the purchase price is capital appreciation. The interest or dividend or

interest received from the investment is the yield. 'ifferent types of investments promise different rates of

returns. The return from an investment depends upon the nature of the investment, the maturity period and a host

of other factors.

Risk: Investments! risk is &ust as important as measuring its expected rate of return because minimi$ing risk and

maximi$ing the rate of return are interrelated ob&ectives in the investment management. The risk of an investment

depends on the following factors%

The longer the maturity period, the larger is the risk

The lower the credit worthiness of the borrower, the higher is the risk

The risk varies with the nature of investment. Investments in ownership securities like e"uity shares carry

higher risk compared to investments in debt instruments like debentures and bonds.

(isk and return of an investment are related. )ormally, the higher the risk, the higher is the return.


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Safety: The safety of an investment implied the certainty of return of capital without loss of money or time.

*afety is another feature which an investor desires for his investments. +very investor expects to get back his

capital on maturity without loss and without delay.

Liquidity: arketability of the investment provides li"uidity to the investment. The li"uidity depends upon the

marketing and trading facility. If a portion of the investment could be converted into cash without much loss of

time, it would help the investor meet the emergencies. *ome investments like company deposits, bank deposits,

Post -ffice 'eposits, )ational *aving ertificates etc. are not marketable. *ome investment instruments like

preference shares and debentures are marketable, but there are no buyers in many cases and hence their li"uidity

is negligible. +"uity shares of companies listed on stock exchanges are easily marketable through the stock

exchanges.

O!ECTIVES OF INVESTMENT

The ob&ectives of an investor can be stated as%

/. aximi$ation of return

0. inimi$ation of risk

1. 2edge against inflation

Investors, in general, desire to earn as large returns as possible with the minimum of risk. (isk here may be

understood as the probability that actual returns reali$ed form an investment may be different from the

expected return. If we consider the financial assets available for investment, we can classify them into

different risk categories. 3overnment securities would constitute the low risk category as they are practically

risk free. 'ebentures and preference shares of companies may be classified as medium risk assets. +"uity

shares of companies would form the high risk category of financial assets. #n investor would be prepared to

assume higher risk only if he expects to get proportionately higher returns there is a tradeoff between risk and

return. The expected return of an investment is directly proportional to its risk. The expected return of aninvestment is directly proportion to its risk. Thus, in the financial market, there are different financial assets

with varying risk return combinations.

The investors in the financial market have different attitudes towards risk and varying levels of risk

bearing capacity. *ome investors are risk averse while some may have an affinity to risk. The risk bewaring

capacity of investors, on the other hand, is a function of his income. # person with higher income is assumed

to have higher risk bearing capacity. +ach investor tries to maximi$e his welfare by choosing the optimum

combination of risk and expected return in accordance with his preference and capacity.

INVESTMENT VS S"EC#LATIONInvestment and speculation are two terms which are closely related. Both involve purchase of assets like

shares and securities. Traditionally, investment is distinguished from speculation with respect to three factors

vi$., risk, capital gain and time period.

Risk: It refers to the possibility of incurring a loss in a financial transaction. It arises from the possibility of

variation in returns from an investment. (isk is invariably related to return. 2igher return is associated with

higher risk.


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)o investment is completely risk free. #n investor generally commits his funds to low risk investment,

whereas a speculator commits his funds to higher risk investments. # speculator is prepared to take higher

risk in order to achieve higher returns.

Ca$ita% Gain: #nother distinction between investment and speculation emphasi$es that if the motive is

primarily to achieve profits through price changes, it is speculation. If purchase of securities is lead by proper

investigation and analysis and review to receive a stable return over a period of times it is termed as

investment. Thus, buying low and selling high, thus making a large capital gain is associated with

speculation.

Ti&e "eri'd: Investment is long term nature, whereas speculation is short term. #n investor commits his

funds for a longer period and waits for his return. But a speculator is interested in short term trade gains

through buying and selling of investment instruments.

DIFFERENCE ET(EEN THE INVESTOR AND THE S"EC#LATOR

Fa)t'r In*est'r S$e)u%at'r

Ti&e Plans for a longer time hori$on Plans for a very short Period

H'ri+'n 2is holding period may be form one year to few years

2olding period varies from few days tomonths

Risk #ssumes moderate risk 4illing to undertake high risk

Return 5ikes to have moderate rate of return

associated with limited risk

5ikes to have high returns for assuming

high risk

De)isi'n onsiders fundamental factors and

evaluates the performance of the company

regularly

onsiders inside information, here says

and market behaviour

Funds 6ses his own funds and avoids borrowed

funds

6ses borrowed funds to supplement his

personal resources.

INVESTMENT "ROCESS

The investment process involves a series of activities leading to the purchase of securities or other

investment alternatives. The investment process can be divided into five stages 7i8 framing of investment policy

7ii8 investment analysis 7iii8 9aluation 7iv8 Portfolio onstruction 7v8 Portfolio evaluation.

In*est&ent "'%i)y: The first stage determines and involves personal financial affairs and ob&ectives before

making investments. It may also be called preparation of investment policy stage. The investor has to see that he

should be able to create an emergency fund, an element of li"uidity and "uick convertibility of securities into

cash. This stage may, therefore, be considered appropriate for identifying investment assets and considering the

various features of investments.

Se)urity Ana%ysis: 4hen a individual has arranged a logical order of the types of investments that he re"uires onhis portfolio, the next step is to analyse the securities available for investment. 2e must make a comparative

analysis of the type of industry, kind of security and fixed vs variable securities. The primary concerns at this

stage would be to form beliefs regarding future behavior or prices and stocks, the expected returns and associated

risk.

Va%uati'n 'f Se)urities: The third step is perhaps the most important consideration of the valuation of

investments. The valuation helps the investor to determine the return and risk expected from any investment in


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the common stock. The intrinsic value of the share is measured through the book value of the share and price

earnings ratio. *imple discounting models also can be adopted to value the share. The stock market analysts have

developed many advanced models to value the shares. The real worth of the share is compared with the market

price and then the investment decisions are made. uture value of the securities could be estimated by using a

simple statistical techni"ue like trend analysis. The analysis of the historical behavior of the price enables the

investor to predict the future value.

"'rtf'%i' C'nstru)ti'n: # portfolio is combination of securities. The portfolio is constructed in such a manner to

meet the investor!s goals and ob&ectives. The investor should decide how best to reach the goals with the

securities available. The investor tries to attain maximum return with minimum risk. Towards this end he

diversifies his portfolio and allocates funds among the securities.

7a8 'iversification% the main ob&ective of diversification is the reduction of risk in the loss of capital and

income. # diversified portfolio is comparatively less risky than holding a single portfolio.

7b8 'ebt and +"uity 'iversification% 'ebt instruments provided assured return with limited capital

appreciation. ommon stocks provide income and capital gain but with the favour of uncertainty. Both

debt instruments and e"uity are combined to complement each other.

7c8 Industry 'iversification% Industries growth and their reaction to government policies differ from each

other. Banking industry shares may provide regular returns but with limited capital appreciation.

7d8 ompany 'iversification% *ecurities from different companies are purchased to reduce risk. Technical

analyst suggests the investors to buy securities based on the price movement. undamental analyses

suggest the selection of financially sound and investor friendly companies.

7e8 *election% Based on the diversification level, industry and company analyses the securities have to be

selected. unds are allocated for the selected securities and the allocation of funds and seal the

construction of portfolio.

"'rtf'%i' E*a%uati'n: The portfolio has to be managed efficiently. The efficient management calls for evaluation

of the portfolio. This process consists of portfolio appraisal and revision.

7a8 #ppraisal% The return and risk performance of the security vary from time to time. The variability in

returns of the securities is measured and compared. The developments in the economy, industry and

relevant companies from which the stocks are bough have to be appraised. The appraisal wants the loss

and steps can be taken to avoid such losses.

7b8 (evision% (evision depends on the results of the appraisal. The low yielding securities with high risk are

replaced with high yielding securities with low risk factor. To keep the return at a particular level

necessitates the investor to revise the components of the portfolio periodically."RIMAR, MAR-ET

The primary market is also known as new issues market . 2ere, the transaction is conducted between the issuer

and the buyer. In short, the primary market creates new securities and offers them to the public.

or instance, Initial Public -ffering 7IP-8 is an offering of the primary market where a private company decides

to sell stocks to the public for the first time. #n important point to remember here is that in the primary market,

securities are directly purchased from the issuer.


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apital or e"uity can be raised in primary market by any of the following four ways%

./ "u0%i) Issue

#s the name suggests, public issue means selling securities to public at large, such as IP-. It is the most vital

method to sell financial securities.

1/ Ri23ts Issue

4henever a company needs to raise supplementary e"uity capital, the shares have to be offered to present

shareholders on a pro:rata basis, which is known as the Rights Issue.

4/ "ri*ate "%a)e&ent

This is about selling securities to restricted number of classy investors like fre"uent investors, venture capital

funds, mutual funds and banks comes under Private Placement .

5/ "referentia% A%%'t&ent

4hen a listed company issues e"uity shares to a selected number of investors at a price that may or may not be

pertaining to the market price is known as Preferential Allotment .

The primary market is also known as the New Issue Market 7)I8 as it is the market for issuing long:term e"uity

capital. *ince the companies issue securities directly to the investors, it is responsible to issue the security

certificates too. The creation of new securities facilitates growth within the economy.

SECONDAR, MAR-ET

In secondary market, the securities issued in the primary market are bought and sold. 2ere, you can buy a share

directly from a seller and the stock exchange or broker acts as an intermediary between two parties.

The secondary market is actually formed by another layer of investors who deal with primary market investor to

buy and sell financial securities such as bonds, futures and stock. These dealings happen in the proverbial stock

exchange.

)ational *tock +xchange 7)*+8 and )ew ;ork *tock +xchange 7);*+8 are some popular stock exchanges.

a&orly, the trade happens between investors without any involvement with the company that issued the securities

in the primary market. pThe secondary market is further divided into two kinds of market.

./ Au)ti'n Market

The auction market is a place where buyers and sellers convene at a place and announce the rate at which they are

willing to sell or buy securities. They offer either the ‘bid! or ‘ask! prices, publicly. *ince all buyers and sellers are

convening at the same place, there is no need for investors to seek out profitable options. +verything is announced

publicly and interested investors can make their choice easily.

1/ Dea%er Market

In a dealer market, none of the parties convene at a common location. Instead, buying and selling of securities

happen through electronic networks which are usually fax machines, telephones or custom order:matching

machines. Interested sellers deliver their offer through these mediums, which are then relayed over to the buyers


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through the medium of dealers. The dealers possess an inventory of securities and earn their profit through the

selling. # lot of dealers operate within this market and therefore, a competition exists between them to deliver the

best offer to their investors. This makes them deliver the best price to the investors. #n example of a dealer

market is the )#*'#!s period through 4all *treet trading, which implied the prevalence of an

unorgani$ed system of dealers who conducted trades via networks. *tock shops existed to buy and sell shares

over:the:counter. In other words, these were unlisted stocks which were sold privately.

-ver time, the notion of -T underwent a change. These days the over:the:counter denotes those stocks which

are not traded over );*+, )#*'#< or #merican *tock +xchange 7#+?8. The over:the:counter implies those

stocks which are traded on the pink sheets or on over-the-counter bulletin boars 7-TBB8. Pink sheets are a

name given to the daily list of stocks published with ask and bid prices by the )ational

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Unit Isapm