Subject: ACCO 40083 – Investment and Risk Management Sections: BSMA
4-10
Presenter: Caitlin Joy Saco Marc Mervin Matthew M. Valdez
Loren San Agustin Jonah Viagedor
John Paul Tamboy
Instructor: Prof. Ezekiel Turgo
Introduction to Investment
1. History and Its Nature
• Investing has been practiced since the dawn of Homo economicus. During
the late Pre- pottery Neolithic period in the prehistoric Middle East
between 8500 and 9500 BCE, village life became established. Inhabitants
of the Jordan Valley took part in the long-distance exchange of obsidian,
cultivated wheat, and sheep with the inhabitants of the Central Anatolian
Plateau and the Zagros-Taurus arc in what is now modern-day Turkey.
The enterprising traders of this era had to weigh the risks and rewards of
these trade expeditions every day as they pursued their goal of generating
money. With a 1500-mile radius and a remarkable diversity of raw
resources, longdistance trade blossomed unlike ever before.
2. Definitions and Objectives Definition
• Investment is any asset into which funds can be placed with the
expectation that it will generate positive income and/or increase its value
and a collection of different investments is called a portfolio.
• An investment is the current commitment of dollars for a period of time in
order to derive future payments that will compensate the investor for the
time the funds are committed, the expected rate of inflation during this
time period, and the uncertainty of the future payment.
• Investment is concerned with the management of an investor's wealth,
which is the sum of the current income and the present value of all future
income.
2 ways:
• Capital Appreciation
• increase in the market price of assets such as equity securities,
mutual funds, real estates, gold. It can be calculated as the
difference between the current value and purchase price of an
investment.
• Income
• comes from direct payment to investors, typically in dividends or
interest coming from stocks, bonds, or certificate of deposits.
Objectives
• Maximizing the return and minimizing the risk. When making an
investment, a frequent goal is to obtain the greatest long-term returns with
the least amount of risk. Normally, the higher the risk, the higher the
potential return. While the lower the risk, the lower the potential return.
That's why investors should spread their investments around to limit the
overall risk of their portfolio.
• Maintaining liquidity. Liquidity is the ability to instantly trade, sell off or
convert assets into cash without having a significant impact on its value.
Assets such as bonds, marketable securities, certificates of deposits, and
treasury bills provide investors enough liquidity.
• Hedging against inflation. Rate of return should cover against inflation to
protect against the rise in prices and fall in the purchasing value of money.
The market value of an investment may decrease due to inflation. The
ideal response to this is to look for investments that provide the most
effective hedge against inflation.
• Increasing safety. Investments help keep investor's hard earned money
or principal safe by focusing on securities that carry a low degree of risk.
Investing in securities like treasury bills or bonds issued by the economy's
top companies comes with low or reduced risks while providing stable
income over time.
• Saving tax. There are certain investment strategies that help minimize the
size and impact of taxation on the overall value of the portfolio. Investors
try to minimize the tax outflow and maximize the tax returns. Certain
investments offer tax incentives which lessen the gains lost to taxes and
increase the return on investment.
3. Kinds • Short- or Long-Term Investments
Short term Investment - have a life of one year or less and usually
carry little or no risk.
Long term Investment - with longer maturities or, like common
stock, with no maturity at all.
• Mutual Funds - Companies that pool money from many investors and
invest funds in a diversified portfolio of securities.
• Common Stock - equity investments that represent ownership in a
corporation.
• Fixed Income Securities - Investments that make fixed cash payments at
regular intervals.
Bonds Convertible Securities Preferred Stock
• Exchange traded funds- Investment funds, typically index funds, that
are exchange listed and, therefore, exchange traded.
• Hedge funds - Alternative investments, usually in pools of underlying
securities, available only to sophisticated investors, such as institutions
and individuals with significant assets.
• Derivative Securities - are neither debt nor equity. Instead, they derive
their value from an underlying security or asset.
• Debt - a loan that obligates the borrower to make periodic interest
payments and to repay the full amount of the loan by some future date.
• Equity - represents an ownership interest in a corporation which provides
a residual claim—after payment of all obligations to fixed-income claims—
on the income and assets of a corporation.
• Other popular investments Tax-advantaged investments Real estate
Tangibles • Direct or Indirect
Direct investment - directly acquires a claim on a security or property.
Indirect Investment - is an investment in a collection of securities and
properties managed by a professional investor.
• Low- or High-Risk Investments
• Low Risk investment - provide a relatively predictable, but also
relatively low, return
• High Risk Investment- provide much higher returns on average,
but they also have the potential for much larger losses.
• Property - consists of investment in real property or tangible
personal property.
Real property - land, buildings, and that which is permanently affixed to
the land.
Tangible personal property - includes items such as gold, atwork,
antiques, and other collectibles.
4. Risk and Return
Investments have inherent risks involved. The concept of risk and return analyzes
the likelihood of risks in investing while measuring the returns from the
investment.
Risks
Risks are the uncertainties associated with the return that investments will
generate. Those risks may come from various sources.
1. Business Risk
- It is the uncertainty associated with an investment’s earnings and its ability to
pay the return expected by the investors. Business risk associated with an
investment is tied to the firm’s industry. The risk in a certain industry’s stock
differs from the risk in another industry’s stock. In general, investments in firms of
similar kinds have the same business risk, but the differences in management,
costs, and location can cause varying levels of risk.
2. Financial Risk
- It is the risk introduced by how a business finances its investments. Use of
common stock to finance investments exposes the firm only to business risk.
Financial risk is the increased uncertainty brought by a firm's borrowing.
3. Liquidity Risk
- It is the risk of not being able to immediately liquidate investment without
reducing its price. An investor who acquires an asset expects that the investment
will mature and will be salable to others. The more difficult it is to convert the
investment into cash, the higher is the liquidity risk. Investments traded in a thin
market tend to be less liquid than those traded in a broad market.
4. Exchange Rate Risk
- It is the uncertainty of returns to investors who acquire securities denominated
in a currency different from their own. The more volatile the exchange rate
between two countries the less certain the investor be about the exchange rate
5. Country Risks/Political Risk
- It is the uncertainty associated with investing in a particular country. This can be
cause by the possibility of major change in political or economic environment of a
country
Return
Return is the gain that investors expect from their investments. Some
investments have guaranteed return while some do not have. The return on
investment comes from two sources. One source is from periodic payments
(income) such as dividends and interest. The other source is the change in price
of the investment (capital gains or losses).
Return on investment is important as it plays a key role in the decision of
investors. Return indicates how rapidly an investor can generate wealth.
Investors prefer investments that will offer high returns than low returns if all else
is equal.
The level of returns from an investment is affected by different factors: internal
characteristics and external forces. Internal characteristics that may affect the
return are the type of investment, the quality of the firm's management, and the
method by how the firm’s operations are financed (debt or equity). External
forces that affect the return are factors beyond the control of the issuer of
investment such as economic changes and political events.
Relationship between Risks and Return
The risk associated with a certain investment has direct correlation with the
return that the investment can give. Higher return expected from investment
involves greater risk while lower return involves lower risk. The reasoning behind
this relationship is that investors who are willing to take more risks on their
investments, and potentially lose money should be rewarded for their risk.
There are ways that can be done to reduce risk maximizing the profit that can be
generated. Diversification of portfolio helps reduce the negative impact of risks.
Investment to a single market may generate greater returns when that market
significantly outperforms the overall market. However, the decline of that sector may
give lower returns. 5. Kinds of Investors What is an investor?
An investor is either an individual or a business entity or a financial entity who takes
their financial capital and puts it (or better, invests it) in a particular commodity,
currency, or company in hopes of making some kind of financial returns in the future.
Most investors generate returns through equity investment, debt investment, or both.
• Equity investment means owning part of a company’s stock. If the stock pays
dividends or raises in value, the investor earns profits. The investor realizes
those profits upon selling the stock.
• Debt investment is structured as a loan. In this case, the business owes a
certain amount of money to the investor and pays it back with interest over time.
Passive and Active Investor
An investor is first categorized based on two main categories – active investor and
passive investor.
• Active Investor
An active investor is someone who constantly checks the market for amazing
investment opportunities and has made investing an integral part of their life.
Active investors take a hands-on approach to managing their portfolios. These
are investors who want to exert influence on the way their assets are run.
Investors like a stock market investor and a cryptocurrency investor can be
categorized as active investors.
Active investors look for opportunities to make operational, financial, and
administrative changes based on their own knowledge and experience. As a
result, active investing usually involves greater risk, but it can also deliver greater
returns when successful. In order to exert influence over company operations,
active investors typically aim for a controlling stake. This also increases exposure
to risk, so these investors spend a great deal of time and energy on financial
analysis and valuation before buying in.
• Passive Investor
On the other hand, a passive investor is an investor that makes long-term
investments that may have poor value at the start but hold a lot of value potential
for the future and can serve as an excellent investment opportunity. An investor
like a mutual fund investor and a real estate investor often come under this
category.
Passive investors limit the amount of hands-on management they personally
provide to assets they own, adopting a buy-and-hold mentality that they expect to
pay off in the long run. This is commonly the case for investors who do not own a
controlling stake in the company they invest in. Passive investors usually invest
in companies with management teams they believe in and rely on those teams
for expertise and guidance.
What are the Different Kinds of Investors?
1. Angel Investors
Angel investors are also referred to as business angels, seed investors, private
investors, angel funders, or information investors. An angel investor is an investor
that has amassed massive amounts of wealth and revenue for themselves. An
angel investor primarily invests in first-time business companies and startups by
purchasing large amounts of their shares. The cash investment that they provide
allows the business to expand, develop or make other planned changes.
Angel investment is normally either a one-time off funding for the business to
propel, or an on-going investment to support and take the company ahead in the
initial stages. Moreover, angel investors may invest alone or as part of a small
group of investors and their motivations for doing so will often be diverse. They
will usually expect to have a direct, hands-on approach to the investment, which
some businesses may find intrusive but which can in fact be of tremendous help
to a growing business.
The ideal candidate for a business angel is a business with a good product or
service and a capable management team, but which needs help with strategic
issues and additional capital in order to take the next step in growing the
business. 2. Peer-to-peer/P2P Lenders
P2P lenders are investors, or groups of individuals, that want to get a better
return on their cash savings than they would get from a bank savings account or
certificate of deposit. Peer-to-peer (P2P) lending is a form of financial technology
that allows people to lend or borrow money from one another without going
through a bank. Instead, an online platform connects an individual in need of
money with other individuals and entities willing to lend it to them. In that sense,
the lenders are also investors.
Each website sets the rates and the terms and enables the transaction. An
investor first opens an account with the site and deposits a sum of money to be
disbursed in loans. From there, lending offers can be made already. When the
lender approves funding a loan, the money will be immediately disbursed or
wired into the borrower’s bank account. The money transfers and the monthly
payments are handled through the platform.
Peer-to-peer lending process can be more advantageous than traditional lending.
P2P marketplaces provide better rates compared with high-interest credit cards
or payday loans. Lenders themselves could potentially generate higher interest
earnings relative to the yield of a checking or savings account. Similar to the
traditional lending model, the borrower makes regular payments, which consist of
a principal amount and interest. The interest charge serves as the investor's
profit, or the premium they earn in return for lending their money.
3. Personal Investors
A personal investor is an individual investor who invests their capital in a
business, or any investment opportunity for that matter, for their own personal
gain. They do not represent a group, and they don't focus just on small
businesses; instead, they invest wherever they see a chance of investment.
A personal investor invests their own capital, usually in stocks, bonds, mutual
funds, and exchange-traded funds (ETFs). Personal investors are not
professional investors but rather those seeking higher returns than simple
investment vehicles, like certificates of deposit or savings accounts.
4. Banks
Banks provide businesses, companies, and individual loans that act as their
"investment." This investment gets a fixed monthly return that is increased by the
interest rate charged by the bank. Even large banks, like investment banking
firms, engage in larger-scale investing by funding expensive projects, buying and
selling companies, and helping governments and organizations raise capital.
Banks are a classic source for business loans. The bank will ask for some form of
security for the overdraft or loan; either a personal guarantee or a charge over
the assets of the business.
5. Venture Capitalists
Venture capitalists are private equity investors, usually in the form of a company,
that seek to invest in startups and other small businesses. In contrast to angel
investors, they do not seek to fund businesses in the early stages to help get
them off the ground, but rather look at businesses that are already in the early
stages with a potential for growth.
Venture capitalists will only invest in a company or business if it has an idea or
growth rate that has the potential to become immensely successful one day. In
the event that a business shows signs of rapid growth in the future, a venture
capitalist will invest a large amount of capital in the business by purchasing an
equity stake, and in return, they will get an overall say in the company’s
decisions.
6. Time Value of Money
Time value of money means that when valuing cash flows in different time
periods, the interest-earning capacity of money must be taken into consideration.
(Rejda, D. 2022) Example:
Assume further that the bank is prepared to provide 2% compound interest per
year on your account. In a year, what will the account balance be? Back then,
you would have your original P100, plus an additional 2 percent of P100, or P2 in
interest:
100 + (100 * .02) = 102
The amount one year from now (the future value, or FV) is obtained by
multiplying the initial sum (the present value, or PV), by one plus the interest rate
I as follows: PV * (1 + i) = FV
Simply multiply the sum at the end of the first year by one plus the interest rate to
get the account balance after two years. This leads us to the straightforward
equation for the future value of a current amount:
PV(1 + 1)n = FV, where "n" is the number of time periods.
Compounding and Discounting
Compounding takes place when you are earning interest on interest (compound
interest), the operation through which a present value is converted to a future
value.
Compounding also works in reverse. Assume that you know the value of a future
cash flow, but you want to know what the cash flow is worth today, adjusting for
the time value of money. Dividing both sides of our compounding equation by (1
+ i) n yields the following expression:
PV = FV (1 + i) n
Thus, if you want to know the present value of any future amount, divide the
future amount by 1 plus the interest rate, raised to the number of time periods.
This operation—bringing a future value back to present value—is called
discounting.
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