Introduction to Investment and Securities

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Introduction toInvestment and Securities

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Chapter Objectives

To understand the concept of investment

To explain process of investment

To learn about various types of securities

To analyze various sources of investmentinformation

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Investment

Investment is the employment of funds on assets to earn income or

capital appreciation.

The individual who makes an investment is known as the investor.

In economic terms, investment is defined as the net addition made to

the capital stock of the country.

In financial terms, investment is defined as allocating money to assets

with a view to gain profit over a period of time.

Investments in economic and financial terms are inter-related where an

individual's savings flow into the capital market as financial investment,

which are further used as economic investment.

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Speculation

Speculation means taking business risks with theanticipation of acquiring short term gain.

It also involves the practice of buying and sellingactivities in order to profit from the price fluctuations.

An individual who undertakes the activity of speculationis known as speculator.

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Difference between

Investor and Speculator

Base Investor Speculator

Time horizon Has a relatively longer planning

horizon. His holding period is

usually of one or more than oneyear.

Has a very short planning

horizon. His holding period

may be few days to months.

Risk return His risk is less./Moderate Return His risk is high/ High Return.

Decision Attaches greater significance to

fundamental factors and

carefully evaluates theperformance of the company.

Attaches greater significance

to market behaviour and

inside information.

Funds Uses his own funds. Uses borrowed funds along

with his personal funds.

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Gambling

Fundamental difference from speculation & Investment

Quick Results

Normally for fun not for income

Highly Risky not based on any economic activity

No surety of return

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Why to Invest?

Longer Life Expectancy

Increase Rate of Taxation

High Interest rates

High Rate of Inflation

Large Income

Availability of a complex no. of investmentoutlets

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Investment ObjectivesReturn Income: The total income, the investor receives during

his holding period.

Risk: Variability in the return.

Liquidity: The ease with which the investment is converted cash.

Tax Shelter: It refers to the legal and regulatory protection tothe investment.

End period value Purchase period value+ Dividends

Return = 100Purchase period value

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Cont.

Hedge against inflation:

The returns should be higher than the rate of inflation.

Convenience:

Ease on making investment and Maintaining it further

Capital Appreciation

Aggressive growth, Speculation, Periodic cash

Receipts, Capital gains

Safety and security of Fund/Stability of Income

Concealability

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Portfolio Management Process

Specification of Investment Objectives/constraints: current

income, capital appreciation, safety of principal

Choice of the assets mix: risk tolerance and investment horizon

of investors

Formulation of portfolio strategy: active or passive

Selection of Securities: fundamental & technical analysis, yield

to maturity, credit rating tax shelter etc.

Portfolio Execution: implementation of the portfolio plans

Portfolio Revision: rebalancing of portfolio

Performance Evaluation: periodic performance evaluation

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Investment Alternatives

Equity

Preference Shares

Debentures

Bonds /Fixed Income Securities

Money Market Instruments

Non- Marketable Financial Assets

Real estate Precious Objects

Insurance Policies

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Securities

They are instruments which represent a claim overan asset or any future cash flows.

Securities are classified on the basis of return and

source of issue.Fixed income securities

Return

Variable income securities

Issuers Government

Quasi-Government

Public Sector Enterprises

Corporates

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Types of Preference Stocks

There are different types of preferencestocks, which are:

Cumulative preference shares

Non-cumulative preference shares

Convertible preference shares

Redeemable preference shares Irredeemable preference shares

Cumulative convertible preference shares

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Equity Shares

Common stock or ordinary shares aremost commonly known as equity shares.

Stock is a set of shares put together in a bundle.

A share is a portion of the share capital of acompany divided into small units of equal value.

The advantages of equity shares are: Capital appreciation

Limited liability

Hedge against inflation

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Sweat EquityIt is a new equity instrument introduced in the

Companies (Amendment) Ordinance, 1998.

It forms a part of the equity share capital as itsprovisions, limitations and restrictions are sameas that of equity shares.

Sweat Equity is for:

The directors or employees involved in the process ofdesigning strategic alliances.The directors or employees who have helped the

company to achieve a significant market share.

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Non-voting Shares

The shares that carry no voting rights are knownas non-voting shares.

They provide additional dividends in the placeof voting rights.

They can be listed and traded on the stock

exchanges.

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Bonus SharesDistribution of shares, in addition to the cash

dividends, to the existing shareholders are

known asbonus shares.These are issued without any payment for cash.These are issued by cashing on the reserves of

the company.

A company builds up its reserves by retainingpart of its profit over the years.

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Preference Stock

Preference stock provides fixed rate of return.

Preference stockholders do not have any votingrights.

Like the equity, it is a perpetual liability of thecorporate.

Preference stockholders do not have any sharein case the company has surplus profits.

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DebentureIt is a debt instrument issued by a company, which

carries a fixed rate of interest.

It is generally issued by private sector companies inorder to acquire loan.The various features of a debenture are:

Interest Redemption Indenture

A company can issue various types of debentures, which

are: Secured or unsecured debenture

Fully convertible debenture

Partly convertible debenture

Non-convertible debenture

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Bonds/Fixed Income Securities

Government Securities

Saving bonds

Private Sector debentures

PSU bonds Preference shares

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Money Market Instruments Treasury Bills

Certificates of deposits Commercial papers

Repos

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Non Marketable financial assets

Bank deposits

Post Office time deposits

Monthly Income schemes of the Post office

Kisan Vikas Patra

National Saving certificates

Company Deposits Employees Provident fund scheme

Public Provident fund Scheme

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Real Estate

Residential House/Flats

Cooperative Group Housing Society Flats

Commercial property

Agricultural land

Suburban land

Time share in a Holiday resort

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Precious Objects

Gold & silver Precious stones/Gems

Art Objects

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Insurance Policies Endowment Policy

Money back Plan

Whole life Insurance

Unit Linked plan Term Insurance

Immediate Annuity

Deferred Annuity

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Decision Process

Finance(Spending) decisions and Investment(Savings)decisions have encompassed the three major areas of

spending in aggregate economy:

GNP = C+I+G+FGNP= Gross National Product

C= spending by Individual for personal consumptionI = Gross private domestic investment by business firms

G = Governmental purchases

F = Net Foreign spending

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Finance decisions: Sources of money

Quantum of money required

Duration of Time for which money needed

Cheapest source for obtaining the require sum of money

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Investment decisions: Budgeting of money Total money available to invest

Allocation of money between current consumption &reinvestment

Optimal rate of total investment

Choice of specific asset to be purchased

Proportion of total money to be invested in a particular asset

Frequency of evaluation of the performance of the portfolio

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Optimal investment decisions can be made only after thesource i.e. the cost of financing will be determined.

Vice versa, since the cost of financing depends upon theexpected profit and risk of the project to be financed, totalcost can be determined only after the investment decisionshas been made.

The investor reinforces his bargaining position by analysingthe investment opportunities offered to him by Businessfinance Manager

The power of selection or rejection forces the financemanager to offer only those opportunities that will meettheir requirements of the mass of investors who make up

market

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Approaches to investment Decision making

Fundamental approach: Based on Intrinsic

Value(undervalued & overvalued)

Psychological approach: Optimistic/Pessimistic

Academic approach: sophisticated methods of

investigation(Market Price, Risk & Return)

Electic approach: Combination of all three

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Investment decision Process

Basic standards & benchmarks Gauging the prevailing mood of investors and relative strengths ofsupply and demand forces

Perceiving that market is not so well ordered

Conduct of some Fundamental analysis to establish certain value

anchors Applying technical analysis to assess the state of the market

psychology

Combine both the above analysis to determine which securities

are of worth buying, worth holding, and worth disposing. Respecting the market price and should not showing excessivezeal in Beating the market

Acceptance of the fact that the research for a higher level of returnoften necessitates the assumption of a higher level of risk.

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Inadequate comprehension of Risk & Return

Vaguely formulated investment policy

Naive Extrapolation of the past

Cursory decision making

Untimely entries & exits

High Cost

Over Diversification & Under diversification

Wrong attitude towards losses & Profit

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Common Errors in Investment Management

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Contrary thinking

Patience

Composure

Flexibility & openness

decisiveness

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Qualities for successful investing

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The Investment Environment Financial Market:

Debt market, Equity Market, Capital Market, Money Market,

Primary Market, Secondary market, Spot market, FutureMarket, Exchange traded market, Off the countermarket(decentralized & customised) , etc.

Financial Instruments:

Creditorship securities, Public debt Instrument, Private debt

instrument, Special debt instrument(PSU Bonds, Certificateof deposits), Ownership securities, Indirect Equities

Financial Intermediaries:

Expedite transfer from one owner to another

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Investment Information

An investor must have adequate knowledgeabout the investment alternatives and marketsbefore making any kind of investment.The various sources from which an investor can

gather the investment information are:Newspapers, Investment dailiesMagazines and JournalsIndustry Reports

RBI BulletinWebsites of the SEBI, RBI and other private agenciesStock market information

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Questions

Discuss in detail the common errors in Investmentmanagement.

What qualities are required for successful investment

Discuss the attribute that one should consider while

evaluating an investment Discuss briefly the key steps involved in Portfolio

management process

Describe briefly the following approaches to investment

decision making: Fundamental

Psychological

Academic

Eclectic

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Introduction to Investment and Securities

Documents

Transcript of Introduction to Investment and Securities