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Introduction to investment

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Introduction to investment

  1. 1. Investment Management Dr. Mohammed Arif Pasha Principal Brindavan College Bangalore - 560063
  2. 2. Investment management Lesson plan • Few stories on investment • Meaning of investment • Concepts of investment (Savings, gambling, arbitrage and speculation) • Difference between investment and Speculation • Types & Objectives of investment • Motives for savings and investment • Features of investment program • Investment decision, factors influencing the same • Factors favorable for investment • Investment process • Types of investors • Investment constraints • Activity
  3. 3. Fox and the grapes
  4. 4. Thirsty crow
  5. 5. INVESTMENT Investment is the sacrifice of some present surplus for the future reward. to meet the future needs. people irrespective background make investment in either physical or financial assets. do not like to keep surplus cash idle it does not return investment in financial assets like securities or deposits or in real assets like properties, gold or other assets. a business invests its excess in securities or project.
  6. 6. • all those who invest – do not benefit from it as investment is a risky activity. • Investment is an art – one should have requisite knowledge. • and careful while investing. • The degree of risk varies depend on the type of investment. – equity shares are attractive but risky – debt instruments like government bonds give less returns but are safe. • To reduce risk and maximize returns, – knowing alternatives before investing is important. • Let us know the concepts of investment.
  7. 7. Concepts relating to investments Savings • Excess of income over expenditure. • Putting money aside to meet emergency. • Encourages the investments through financial intermediation and flow of funds in the capital market. • The saver has a low risk and short time preference. • They are bank deposits, post office deposits etc. • Often called cash investments. • Best after tax return coupled with low risk and ready accessibility. • Return is in the form of interest. • People save as a precaution for increasing their wealth.
  8. 8. Gambling • Is a very short term investment in a game of chance. • Involves high risk and the expectations of high returns. • Consists of uncertainty and high stake for thrill and excitement. • Typical examples are horse racing, card game, lottery etc. • Based on rumours, tips and hunches. • Is unplanned, non-scientific and without knowledge of the exact nature of risk.
  9. 9. Characteristics of gambling • It is a typical, chronic and repetitive experience. • The gamblers never stop while winning. • They enjoy a strange thrill from gambling, both pleasure and pain. • They displays optimism without winning the game • They risk more than what they can afford.
  10. 10. Arbitrage • A planned method of putting the savings safely into different investments to get a better return. • A mechanism to keep ones risk to the minimum by hedging and taking advantage of price differences. • A simultaneous purchase and sale of an asset in order to profit from a difference in the price. • This takes place on different exchanges or market places. • one can be an arbitrageur if he buys and sells securities in more than one stock exchange to take advantage of the price differentials in such exchanges.
  11. 11. Speculation • It is as an involvement of funds of high risk and more uncertain expectation of returns. • It is for short period where people buy assets with the hope to earn profit from a subsequent price change. • It is based on the expectation that some change will occur. • Stock brokers are as an example who buy shares to make quick profit by selling when the prices of such shares shoot up.
  12. 12. • Speculation involves a higher level of risk and more uncertain expectation of returns. • Specialized knowledge is essential for the success. • They feel the market which enables them to sense the changes. • A speculator takes action only when things are higher in his favour, but he may not be right all the time. • If he is right half of the time he is hitting a good average.
  13. 13. How Speculation differs from investment? Basis Speculation Investment 1 Contract type Ownership Creditor 2 Source of income change in market price Earning of enterprise 3 Objective of purchase Tips, hunches etc Higher return 4 Stability of income Uncertain Stable 5 Risk involved High Low 6 Duration Short Long 7 Acquisition On margin Outright purchase 8 Attitude Aggressive Conservative
  14. 14. How investment is different from speculation? RISK • In speculation, possibility of incurring a loss in a financial transaction. As involvement of funds of high risk, the degree of risk cannot be exactly drawn as it arbitrary. Some carry high risk & some carry low risk. • Investment involves limited risk and confined to safety avenues. The amount of risk helps in understanding between the terms investment and speculation. Capital gain • If the motive is only to make profit through price changes, it is speculation. Buying at low and selling at high making large profit, is speculation. • But if purchase of securities is preceded by proper investigation and analysis and review to receive stable return over a period of time, it is termed as investment. Time • A longer-term fund allocation is termed as investment while short-term holding is for the quick return is called speculation.
  15. 15. TYPES OF INVESTORS • The various investors are: • Those receive large amount by way of redundancy or retirement benefit. • Those who win large amount from lottery and others sources. • Small investors. • People who wish to set aside regular sum of money to build up funds for future for house or for holiday.
  16. 16. Objective of investment yield choice Minimum comfort Capital appreciation
  17. 17. Objectives of investment Yield • Higher the yield, higher is the risk taken by the investors. risk less return is the bank deposit as the risk is least with safe funds and returns are certain. Choice • Those who are risk averse put their funds in bank or post office deposits, some invest in real assets, and land and buildings while others invest mostly in gold, silver and diamonds. Minimum comforts • Every investor aims at providing for minimum comforts or a home, furniture, vehicles, consumer durables and other household requirements. After satisfying these minimum needs, he plans for his income, savings in insurance, pension and provident funds etc. In the choice of these, the return is subordinated to the needs of the investor. Capital appreciation • Savings would be invested in financial assets to get future incomes and capital appreciation to improve future standard of living. These may be in stock, capital market investments.
  18. 18. Motives behind savings Precautionary Transaction speculative
  19. 19. Motives for savings and investments • The motives behind savings or investments are: Precautionary motive • The world which is full of uncertainty which may arise any time and to protect from such emergencies, people save or invest money and take precautions. Transaction motive • Transaction motive refers to requirement of cash for the conduct of day to day activity, and cash being a legal tender, these are settled through cash. money is needed to meet the daily requirements which may be inflow or outflow of cash. Speculative motive • People make use of the opportunities, from unexpected future. This is generally done in the stock market where shares are bought and sold by the brokers to take advantage of the rise or fall in the value of shares.
  20. 20. Features of investment program • The features of investment program consist of : • Liquidity • Safety of principal • Tax benefits • Income stability • Purchasing power • Capital growth
  21. 21. Investment Decision Investment decision is based on the • availability of money and information • in the economy, industry and company and the • share prices ruling and expectations of • the market and of the companies in question.
  22. 22. Factors influencing the investment decisions 1 • Investment decision depends on the mood of the market. • share prices depend on the company’s fundamentals upto 50% and the rest is decided by the mood of the market and the company’s performance. • These expectations depend on the analyst’s ability to foresee and forecast the future performance of the company. • Present prices depends on the flow of returns in future from the company.
  23. 23. 2 • Decision to invest is based on the past performance, present and the future expectations of the company’s performance, both operationally and financially which will influence the share prices.
  24. 24. 3 • Investment decision depends on – the investor’s perception on whether the present share price is fair, over valued or under valued. • If the share price is – fair, investor will hold it, – over valued, will sell it and – under valued, will buy it. • some investors may buy as their expectations of further rise even if prices go high. • The concepts of overvaluation or undervaluation is relative to time, space and man. • What may be overvalued today may undervalued later following later developments; information or sentiment and mood of the market scenario and of the valuation of shares.
  25. 25. 4 • The investment decision may also depend on the – investor’s preference, mood or fancies. • He may invest in – cats and dogs of companies, if he has taken a fancy or he flooded with money from lottery or prizes. • A rational investor would make investment decisions – on scientific study of the fundamentals of the company and in a planned manner.
  26. 26. 5 • Investors decision depend on – hearsay and advice of friends, relatives, sub- brokers etc. and not on any scientific study of the company’s fundamentals. • Due to mushroom growth of companies and lack of any track record of promoters, – risk will increase if all investments made on hunches, hearsay.
  27. 27. Factors favorable for investment • Business activities are affected by social, economic and political considerations and • hence it is important that the political and economic institutions are favorable. • Generally there are four basic considerations which foster growth and bring opportunities for investment. These are: – (a) Legal safeguards, – (b) Stable currency, – (c) Existence of financial institutions to aid savings and – (d) Form of business organizations.
  28. 28. INVESTMENT PROCESS • Preliminary Screening • Negotiating Investment: It needs an agreement between the venture capitalist and management to have a MoU. Then, venture capitalist will the viability of the market to estimate its potential. they use market forecasts through industry experts who specialize in estimating the size and growth rates of markets and segments. • Approvals and Investment Completed: This involves due diligence and disclosure of all relevant business information. Final terms will be negotiated and the proposal is submitted to the fund’s board of directors. If approved, legal documents are prepared.
  29. 29. Investment Media • The various media of investment are as follows: • Direct investment alternatives • Fixed principal investment • Cash, (b) Savings account, (c) Saving certificates, (d) Government bonds and • (e) Bonds and debentures • Variable principal securities • Equity shares, (b) Convertible debentures or preference securities • Non-Security Investments • Real estate, (b) Mortgages, (c) Commodities, (d) Business ventures, (e) Art, antiques and other valuables. • Indirect Investment Alternatives • Pension fund, (b) Provident fund, (c) Insurance, (d) Investment companies and • (e) Unit Trust of India and other trust funds.
  30. 30. INVESTMENT PROCESS • Investment management is a risky and complex activity. The process on investment involves the following steps: • Objective specification: Investors will always consider their present income, safety of principal and capital appreciation. The investing, must consider in each kind of asset with its specific restrictions with regard to liquidity, maturity and tax. • Mix of asset: Investment should be made in assets like equity shares, bonds, fixed income securities, bank deposits. Equity shares yield better returns but carry risk, while others are less risky but yield less returns. The appropriate mix of debt and equity generally depends on the risk tolerance of the investor. • Portfolio formulation strategy: Choose to take a risky investment to earn better risk adjusted returns or can diversify investment at a pre determined level of risk. • Selection of securities: Do a fundamental analysis or technical analysis of the security to select stock. consider credit rating of an instrument, tax shelter, yield to maturity and liquidity to select bonds or other fixed income securities. • Portfolio Revision: Revise portfolio by changing composition of securities to rebalance the portfolio of securities. • Portfolio evaluation: Evaluate the performance of portfolio from time to time because risk and return are the key issues. Such an evaluation provides a useful feedback to improve the quality of portfolio management on a regular basis.
  31. 31. Types of investors • Depending on the attitude towards risk, investors are classified into three types: • varying levels of risk bearing investors in the market. • Factors like income, tax liability, risk perception, size of the family, age, education, gender etc., influences the investors to take decisions. • Some investors have affinity for risk while others are risk averse. • A person with better income is assumed to have higher risk bearing capacity. • The various types of investors are risk takers, risk neutrals and risk averters.
  32. 32. Investment Constraints • A plan must consider both investment objectives and constraints. • Major constraints include – liquidity, – time horizon, – tax concerns, – legal and regulatory concerns and – unique circumstances.
  33. 33. Liquidity refers to the need for cash in excess of any savings or new contributions available at a specific point in the future. A Liquidity needs may be planned (child’s college funding in 10 years) or unplanned (a medical emergency) but both require ready ability to convert investments into cash. Some assets, such as real estate, may take considerable time to sell. Others, such as certificates of deposit, may impose early withdrawal penalties.
  34. 34. • Time horizon typically refers to the time at which an investment objective must be met. • Some objectives such as saving for a house may have a short time horizon, • while retirement or endowment planning can have long horizons. Investors must often plan for several time horizons at once. • The time horizon influences the ability to accept risk and could modify asset allocation strategy. • Investors with little tolerance for temporary return fluctuations may need a different plan than would be suggested by time horizon alone, and multiple time horizons can further constrain allocation decisions.
  35. 35. • Tax concerns include differences between the tax rates for different types of investment • Return (interest versus capital gains or dividends), estate taxes, differences between current income, retirement income, tax rates, and the potential for tax legislation to change. • Legal and regulatory factors may include limits on the allocation to specific assets, the ability to access certain funds and even prohibitions on certain investments. • Unique circumstances may include social concerns and specific family needs.
  36. 36. Topics for the next class • Financial instruments • Money market instruments • Capital market instruments • Derivatives