Concept of Investment

• Investment Attributes, Economic vs. Financial Investment, Investment

and speculation, Features of a good investment, Investment Process.
Financial Instruments: Money Market instruments, Capital Market
Instruments. Derivatives.
What is an Investment?
• Investment is the employment of funds on Assets with the aim of
getting return on it.
• In finance, investment means the purchase of ASSET with an
expectation of favourable future returns.
• An investment is the current commitment of rupee 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.
Definition of Investment
• "Sacrifice of certain present value for some uncertain future value" –
WILLIAM F. SHARPE

• "Purchase of a financial asset that produces a yield that is

proportional to the risk assumed over some future investment
period" – F. AMLING
Concepts of Investment
Business Investment: Business investment refers to the money put in
to a private business. It is the amount with which a person starts his
business or the additional amount which he puts in later on. If a
business unit is set up and an amount of Rs. 10 lakhs is spent on it, this
will be a business investment.
Economic Investment: The concept of economic investment means
addition to the capital stock of the society. The term investment implies
the formation of new and productive capital in the form of new
construction and producer’s durable instrument such as plant and
machinery. Thus, an investment, in economic terms, means an increase
in building, equipment, and inventory
• Financial Investment: This is an allocation of monetary resources to
assets that are expected to yield some gain or return over a given
period of time. It means an exchange of financial claims such as
shares and bonds, real estate, etc.
• investment is a commitment of funds to derive future income in the
form of interest, dividends, rent, premiums, pension benefits and the
appreciation of the value of their principal capital. The economic and
financial concepts of investment are related to each other because
investment is a part of the savings of individuals which flow into the
capital market either directly or through institutions
Economic vs. Financial Investment
 Types of Assets

Financial Assets Real Assets

• Stocks • Land
• Bonds • Buildings
• Bank Deposits • Inventory
• Trade Receivables • Precious Metals
• Commodities
• Real Estate
• Machinery
Financial and Real Assets
⮚ A financial asset is a non-physical asset whose value derived from a
contractual claim such as bank deposits, bonds and stocks.

⮚ Financial assets are usually more liquid than other tangible assets,
such as real assets.

⮚ Financial assets may be traded on financial markets.

Investment Attributes
• Return Potential: This refers to the potential for an investment to
generate profits or returns over a specified period. Higher return
potential is often associated with higher risk investments.
• Risk Profile: Risk profile describes the level of risk associated with an
investment. This includes factors such as volatility, liquidity risk, credit
risk, and market risk. Investors typically seek investments that align with
their risk tolerance.
• Liquidity: Liquidity refers to how quickly an investment can be bought
or sold without significantly affecting its price. Investments like stocks
and bonds are generally more liquid than real estate or private equity
investments.
• Time Horizon: The time horizon is the length of time an investor expects to hold an
investment before needing to access the capital. Different investments may be more
suitable for short-term or long-term investment horizons.
• Diversification Potential: Diversification involves spreading investments across
different assets to reduce overall risk. Investments with high diversification potential
can help investors manage risk within their portfolio.
• Tax Efficiency: Some investments are more tax-efficient than others. Understanding
the tax implications of an investment can help investors minimize their tax liabilities
and maximize after-tax returns.
• Income Generation: Some investments, such as bonds or dividend-paying stocks,
provide regular income in the form of interest payments or dividends. For investors
seeking income, the ability of an investment to generate cash flow is an important
attribute.
• Capital Preservation: Certain investments, such as government bonds
or money market funds, are considered relatively safe and are focused
on preserving capital rather than maximizing returns.
• Growth Potential: Growth investments are expected to increase in
value over time. Investors interested in capital appreciation often seek
investments with high growth potential.
• Environmental, Social, and Governance (ESG) Factors: ESG factors refer
to environmental, social, and governance criteria that can impact the
sustainability and ethical impact of an investment. Increasingly,
investors are considering ESG factors alongside financial metrics when
making investment decisions.
Objectives of Investments
• 1) Main objectives
a) Maximizing the return
b) Minimizing the risk
• 2) Subsidiary objectives
a) Maintaining liquidity
b) Hedging against inflation
c) Increasing safety
d) Saving tax
(a) Maximizing the return: Investors always expect a good rate of
return from their investments. The rate of return could be defined
as the total income the investor receives during the holding period,
stated as a percentage of the purchasing price at the beginning of
the holding period.

(b) Minimizing the risk: The risk of holding securities is related to the
probability of the actual return becoming less than the expected
return. The word 'risk' is synonymous with the phrase 'variability of
return‘. An investment whose rate of return varies widely from one
period to another is considered riskier than one whose return does
not change much
• Maintaining Liquidity: Liquidity is an important aspect of any
investment option as it determines the ease, time and cost involved in
converting the investment into cash. Liquidity depends upon
marketing and trading facilities. If a portion of the investment could
be converted into cash without much loss of time, it helps the
investor to meet emergencies
• Increasing safety : Each investment option is differently affected by
different types of risk. Risk affects not only the return on investment
but also return of the investment itself. The selected investment
avenue should be under the legal and regulatory framework.
• Hedging against inflation: The rate of return should ensure a cover
against inflation to protect against a risk in prices and fall in the
purchasing value of money. The rate of return should be higher than
the rate of inflation, otherwise, the investor will experience loss in
real terms.
• Tax is unavoidable: Different income levels and investment options
attract different tax rates. The tax rate may vary with the period of
investment for a specific option. Certain investments offer tax
incentives. The investor tries to minimize the tax outflow
• "Speculation is an activity, quite contrary to its literal meaning, in
which a person assumes high risks, often without regard for the safety
of their invested principal, to achieve large capital gains.“
• The time span in which the gain is sought to be made is usually very
short.
• They are based on tips, and rumours
• A speculator does not buy goods to own them, but to sell them later.
The reason is that speculator wants to earn profit from the changes of
market prices
Factors Affecting Investment Decisions
1) Amount of Investment: The amount of funds available for
investment will influence the form of investment. In case of an
individual investor the amount may be small. There are a number of
avenues for making such investments like bank deposits, mutual
funds, etc. if the investible funds are more than transferable
financial securities like shares, debentures etc. may be purchased.
Investment in real estate can be thought of if the amount is large.
2) Purpose of Investment: The purpose of investment must be very
clear before making it. The object of an individual investor may be
to save tax, earn fixed return, appreciation in the value of securities,
etc.
3) Type of Investment: Another important factor which influences
investment decision is the selection of securities. A decision about
where to invest is very important. A number of securities are available
in the market and which one suits the investor's objective should be
taken up. Varied securities may be taken up to suit different needs
4) Timing of Purchase: The time of purchasing securities is very
important. A proper timing of purchase and sale of securities can bring
profits to the investor. The securities should be purchased when their
prices are low and should be sold when their prices have arisen.
5) Mood of the Market: Investment decision depends on the mood of
the market. share prices depend on the fundaments of the company
only to the extent of 50% and the rest is decided by the mood of the
market and the expectations of the company's performance
6) Investor's Perception: Investment decision will also depend upon the
investor's perception on whether the present share price is fair,
overvalued or undervalued. If the share price is fair he will hold it (Hold
Decision), if it is overvalued, he will sell it (Sale Decision) and if it is
undervalued, he will buy it (Buy Decision).
7) Environmental Considerations: His past background, family
requirements, the assets of neighbours or of colleagues and other
external factors may influence his investment decisions.
Derivatives
• A derivative is a contract between two parties which derives its
value/price from an underlying asset. The most common types of
derivatives are futures, options, forwards and swaps
• It is a financial instrument which derives its value/price from the
underlying assets.
• Derivative trading happens over the counter or via an exchange. Over-
the-counter trading works between two private parties and is not
regulated by a central authority.
Underlying assets
• Stocks
• Commodities
• Currency
• Index
Derivatives Explained in One Minute - YouTube
Types of derivatives
• Forwards
• Futures
• Options
• swaps
Forward
• A forward contract is a customized derivative contract obligating
counterparties to buy (receive) or sell (deliver) an asset at a specified
price on a future date.
• tailor-made contract
• does not trade on any centralized exchange
• Forward contracts are bilateral
• Specific in terms of :
the price of underlying to be exchanged
quality of the underlying
date of delivery
quantity
• Fixed: Settlement is restricted to one future date only
• Open: Fully flexible, allowing settlement at any time up to the
maturity date
• Window: Can be utilised within a window of time up to the maturity
date
Risks of A Forward Contract
• A forward contract can be breached at any time and due to the
following reasons:
• If one party fails to honor the deal.
• Market conditions disfavor one of the parties, for example, a huge
decline or increase in the price prompting the buyer and seller to
default respectively.
• Legal ramifications: – in such a case, it’s only a strong legal team that
could make a strong case against the defaulter.
Futures
• A future contract is typically an agreement entered between parties
to sell or buy some underlying financial assets at an agreed upon date
and price in the future. A futures contract, unlike a forward contract,
is traded in an exchange.
liquidity Less liquid Highly liquid
options
• Options are financial derivatives that give buyers the right, but not the
obligation, to buy or sell an underlying asset at an agreed-upon price
and date.
• Call options allow the holder to buy the asset at a stated price within
a specific timeframe.
• Put options, on the other hand, allow the holder to sell the asset at a
stated price within a specific timeframe.
• Swap contracts take place between two parties Over-The-Counter
(OTC). a swap is an agreement between
two counterparties to exchange financial instruments, cashflows, or
payments for a certain time.
• Interest Rate Swaps: A mortgage holder is paying a floating interest
rate on their mortgage but expects this rate to go up in the future.
Another mortgage holder is paying a fixed rate but expects rates to
fall in the future. They enter a fixed-for-floating swap agreement.
Both mortgage holders agree on a notional principal
amount and maturity date and agree to take on each other's payment
obligations.
Advantages Of Derivatives
• Hedging
• Arbitrage
• Mitigating Market Volatility
Investment Avenues
• Equity
• Debentures
• Bonds or Fixed Income Securities:Government Bonds, Savings Bonds, Private Sector bonds, PSU
bonds
• Money Market Instruments
• Non-marketable Financial Assets: Bank deposits, Post Office Term Deposits, National Savings
Certificate, Employees Provident Fund Scheme, Public Provident Fund (PPF)
• Real Estate
• Precious Objects
• Insurance Policies: Endowment, Money Back Plans, Whole Life Assurance, ULIP
• Pension Funds: National Pension Scheme (NPS), Private Pension Funds
• Mutual Fund: Open ended scheme, Close ended scheme, Interval schemes, Income Fund Scheme,
Growth Fund Scheme, Conservative Fund Scheme, Equity Fund Scheme, Bond Scheme Fund