INTRODUCTION

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INTRODUCTION

The term investment refers to exchange of money wealth into some


tangible wealth. The money wealth here refers to the money (savings)
which an investor has and the term tangible wealth refers to the assets the
investor acquires by sacrificing the money wealth.

“ A shilling today is more valuable than a shilling tomorrow”- time value for money
Definition:
“Investment may be defined as an activity that commits funds in any
financial/marketable or physical form in the present with an expectation of
receiving additional return in the future.” For example, a Bank deposit is a
financial asset, the purchase of gold is a physical asset and the purchase of
bonds and shares is marketable asset.

“Investment is the commitment of current funds in anticipation of


receiving larger inflow of funds in future, the difference being the
income”. An investor hopes to be compensated for (i) forgoing present
consumption, (ii) for the effects of inflation, and (iii) for taking a risk.

Features:
There are three basic features common to all types of investment:
1. There is a commitment of present funds.
2. There is an expectation of some return or benefits from such
commitment in future, and

3. There is always some risk involved in respect of return and the


principal amount invested.

OBJECTIVES OF INVESTMENT:

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1. RETURN:

Investors expect a good rate of return from their investments. Return


from investment may be in terms of revenue return or income (interest
or dividend) and/or in terms of capital return (capital gain i.e. difference
between the selling price and the purchasing price). The net return is the
sum of revenue return and capital return.

For example, an investor purchases a share (Face Value FV Rs.10) for


Rs.130. After one year, he receives a dividend of Rs.3 (i.e. 30% on FV
of Rs.10) from the company and sells it for Rs.138. His total return is
Rs.11, i.e., Rs.3 + Rs.8. The normal rate of return is Rs.11 divided by
Rs.130 i.e., 8.46%.

In the same case, if he is able to sell the share only for Rs.128, then his net return is
Re.1 (i.e.,
Rs.3 – Rs.2) only. The annual rate of return in this case is 0.77% (i.e., 1/130)

a) Expected Return:
The expected return refers to the anticipated return for some future
period. The expected return is estimated on the basis of actual returns in the past
periods.

b) Realised Returns:
The realized return is the net actual return earned by the investor over the
holding period.It refers to the actual return over some past period.

2. RISK:
Variation in return i.e., the chance that the actual return from an
investment would differ from its expected return is referred to as the
risk. Measuring risk is important because minimizing risk and
maximizing return are interrelated objectives. There are two types of

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risk i.e. Systematic Risk and Unsystematic Risk which is discussed in
detail later in this chapter.

3. LIQUIDITY:
Liquidity, with reference to investments, means that the investment is
saleable or convertible into cash without loss of money and without loss of
time. Different types of investments offer different type of liquidity. Most of
financial assets provide a high degree of liquidity. Shares and mutual fund
units can be easily sold at the prevailing prices. An investor has to build a
portfolio containing a good proportion of investments which have relatively
high degree of liquidity.Cash and money market instruments are more liquid
than the capital market instruments which in turn are more liquid than the
real estate investments. For ex, money deposited in savings a/c and fixed
deposit a/c in a bank is more liquid than the investment made in shares or
debentures of a company.

4. SAFETY:
An investor should take care that the amount of investment is safe.
The safety of an investment depends upon several factors such as the
economic conditions, organization where investment is made, earnings
stability of that organization, etc. Guarantee or collateral available
against the investment should also be taken care of. For ex,

 Bonds issued by RBI are completely safe investments as


compared with the bonds of a private sector company.

 Like wise it is more safer to invest in debenture than of


preference shares of a company

 Accordingly, it is more safer to invest in preference shares than


of equity shares of a company, the reason being that in case of
company liquidation, order of payment is debenture holders,
preference share holds and then equity share holders.

5. TAX BENEFITS:

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Investments differ with respect to tax treatment of initial investment,
return from investment and redemption proceeds. For example,
investment in Public Provident Fund (PPF) has tax benefits in respect of
all the three characteristics. Equity Shares entails exemption from
taxability of dividend income but the transactions of sale and purchase
are subject to Securities Transaction Tax or Tax on Capital gains.
Sometimes, the tax treatment depends upon the type of the investor.

The performance of any investment decision should be measured by its after tax
rate of return. For example, between 8.5% PPF and 8.5% Debentures, PPF
should be preferred as it is exempt from tax while debenture is subject to tax in
the hands of the investors.

6. REGULARITY OF INCOME:

The prime objective of making every investment is to earn a stable


return. If returns are not stable, then the investment is termed as risky.
For example, return (i.e. interest) from Savings a/c, Fixed deposit a/c,
Bonds & Debentures are stable but the expected dividends from equity
share are not stable. The rate of dividend on equity shares may fluctuate
depending upon the earnings of the company.

CHARACTERISTICS OF INVESTMENT:
1. RETURN
2. RISK
3. SAFETY
4. LIQUIDITY
5. TIME HORIZON
(Refer objectives of investment topic notes)

INVESTMENT & SPECULATION:

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In speculation, there is an investment of funds with an expectation of
some return in the form of capital profit resulting from the price change
and sale of investment. Speculation is relatively a short term investment.
The degree of uncertainty of future return is definitely higher in case of
speculation than in investment.

In case of investment, the investor has an intention of keeping the


investment for some period whereas in speculation, the investor looks
for an opportunity of making a profit and “exit- out” by selling the
investment.

DIFFERENCES IN INVESTMENT & SPECULATION:

FACTOR INVESTEMENT SPECULATION

1. Degree of risk Relatively lesser Relatively higher

2.Basis of return Income and capital gain Change in market price

3. Basis for decision Analysis of fundamentals Rumors, tips, etc

4.Position of investor Ownership Party of an agreement

5.Investment period Long term Short term

INVESTMENT ALTERNATIVES

One may invest in:

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Physical assets like real estate, gold/jewellery, commodities etc. and/or
Financial assets such as fixed deposits with banks, small saving instruments with
post offices, insurance/provident/pension fund etc. or

Marketable assets - securities market related instruments like shares, bonds,


debentures, derivatives, mutual fund etc.

CLASSIFICATIONS OF INVESTMENT ACTIVITIES:

1. DIRECT INVESTING:
Direct investing involves the buying and selling of securities by
investors themselves. The securities may be capital market securities
such as shares, debentures or derivative products, or money market
instruments such as Treasury Bills, Commercial Bills, Commercial
Papers, Certificates of Deposits, or real assets such as land and
building, house, etc or non-financial assets such as gold, silver, art,
antiques, etc.
2. INDIRECT INVESTING:
Investors may not directly invest and manage the portfolio,
rather they buy the units of funds that hold various types of
securities on behalf of the investors example, Mutual funds, Public
Provident fund (PPF), National Savings Scheme (NSS), National
Savings Certificate (NSC), and investment in Insurance Company
schemes.

INVESTMENT PROCESS

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Investment process of securities as follows:

1. Investment Policy:

The government or the investor before proceeding into investment,


formulates the policy for the systematic functioning. The essential

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ingredients of the policy are the investible funds, objectives and the
knowledge about the investment alternatives and market.

a) Investible funds: The entire investment procedure revolves around the


availability of investible funds. The fund may be generated through
savings or borrowings. If the funds are borrowed, the investor has to be
extra careful in the selection of investment alternatives. The return should
be higher than the interest he pays. Mutual funds invest their owner’s
money in securities.

b) Objectives: The objectives are framed on the premises of the required


rate of return, need for regularity of income, risk perception and the need
for liquidity. The risk taker’s objective is to earn high rate of return in the
form of capital appreciation, whereas the primary objective of the risk
averse (person not interested in taking risk) is the safety of the principal.

c) Knowledge: The knowledge about the investment alternatives and


markets plays a key role in the policy formulation. The investment
alternatives range from security to real estate. The risk and return
associated with investment alternative differ from each other. Investment
in equity is high yielding but has more risk than in fixed income
securities.

2. Security Analysis:

After formulating the investment policy, the securities to be bought have to be


scrutinized through the market, industry and company analysis.

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Market Analysis: The general economic scenario is reflected in the stock
market. The growth in gross domestic product and inflation are reflected in
the stock prices. The recession in the economy results in a bear market.
The stock prices may be fluctuating in the short run but in the long run
they move in trends i.e. either upwards or downwards.

Industry Analysis: The industries that contribute to the output of the


major segments of the economy vary in their growth rates and their overall
contribution to economic activity. Some industries grow faster than the
GDP and are expected to continue in their growth. For example, IT
industry has higher growth rate than the GDP in 1998. The economic
significance and the growth potential of the industry have to be analysed.

Company Analysis: The Company’s earnings, profitability, operating


efficiency, capital structure and management have to be analysed. These
factors have direct bearing on the stock prices and the return of the
investors. Appreciation of the stock value is a function of the performance
of the company. Company with high product market share is able to create
wealth to the investors in the form of the capital appreciation.

3. Valuation:

The valuation helps the investor to determine the return and risk expected
from an investment in the common stock.

Intrinsic Value: Intrinsic value is the present value of securities of all future
cash inflows by using simple discounting models.

Future Value: Future value of the securities could be estimated by using a


simple statistical technique like trend analysis. The analysis of the

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historical behaviour of the price enables the investor to predict the future
value.
4.Construction of Portfolio:
A portfolio is a combination of securities. The portfolio is constructed in such a
manner to meet the investor’s goals and objectives.

Diversification: The main objective of diversification is the reduction of


risk in the loss of capital and income. A diversified portfolio is
comparatively less risky than holding a single portfolio. Various types of
diversification are:

1) Debt – equity diversification

2) Industry diversification

3) Company diversification
Selection: Based on the diversification level, industry and company analyses
the securities have to be selected. Funds are allocated for the selected
securities.

4.Evaluation:
The portfolio has to be managed efficiently. The efficient management calls
for evaluation of the portfolio.

Appraisal: 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 bought have to be appraised. The
appraisal warns the loss and steps can be taken to avoid such losses.

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Revision: Revision 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.

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