SHS

Business Finance

Q2 – Week 3
 BUSINESS FINANCE
WORKSHEET #14

Lesson 14: Types of Investments

At the end of the lesson, you should be able to compare and contrast the different types of
investments.

What’s New?

We simply define investment as money which is committed with an intention to earn a return over a
period of time. However, Brown and Reilly (2014) defined investment as “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 future payments.”

Investments do not have to be in dollars but may be denominated in any other currency depending on
the country of investment.

There are different types of investments which can be grouped into three like:

1. Fixed Income and Equity

a) Bank Deposits. These are money placed into a banking institution for safekeeping.

Bank Deposits are of different types but the most popular of them are: Savings account,
Checking or Current account, and Time deposit account.

A typical savings account provides a low fixed rate of return but provides the
convenience of availability.

Checking account, also, has a very low rate of return but a depositor can issue checks from his
account to pay various expenditures instead of delivering bills or coins as payment.

A Time deposit account usually requires a minimum amount of deposit with a fixed term to
maturity but with higher return compared to savings and checking account. The time depositor
cannot withdraw from his account before the fixed date, but sometimes Time deposits are pre-
terminated.

Deposits with banks are insured with the Philippine Deposit Insurance Corporation (PDIC) up to
₱500,000 per depositor for every bank.

Depositors need to determine the bank’s overall financial position and performance before
transacting with them. A comprehensive rating system was developed in assessing the overall
condition of the bank. This CAMELS rating system is based on the following components:

1. Capital adequacy
2. Asset quality
3. Management indicators
4. Earnings quality
5. Liquidity
6. Sensitivity to risk factors
 A bank may be graded with a CAMELS rating of 1 as the highest and 5 as the lowest rating
possible. The depositor may ask the bank for the CAMELS rating assessed by the Bangko
Sentral ng Pilipinas (BSP).

How is this type of investment assessed? Simply go to a bank (BDO, BPI, Metrobank, Landbank,
etc.) and open a bank account by signing the necessary account opening form. Minimum
amount will also be required depending on which bank and the type of bank deposit you want to
open.

b) Stocks- type of security that signifies ownership in a corporation and classified under two main
categories: Common stock and Preferred Stock.

Preferred stocks differ from common shares in terms of preference as to dividends, seniority
over claims to assets, and the absence of voting rights. Corporations are not required to pay
dividends annually to preferred stockholders but when they declare dividends, preferred
shareholders are paid first before common shareholders. In case of liquidation, preferred
shareholders also have preference over claims to the assets relative to common shareholders
but not over creditors. Preferred shareholders also do not have voting rights in stockholder’s
meetings.

How to avail of stock investment? Go to a stock brokerage firm (i.e. COL Financial, AB Capital
Securities, etc.) or a bank with a stock brokerage arm and open a stock market account by
signing necessary account opening forms. Minimum capital amount, depending on the broker,
will be required to be deposited to successfully open the account (i.e. PHP5,000 for BPI Trade,
PHP10,000 for AB Capital Securities, etc.) most of these brokerage firms now provide online
access to their client’s stocks account (i.e. www.colfinancial.com, www.bpitrade.com,
www.abcapitalsecurities.com.ph, etc).

c) Bonds- debt investments where an investor loans money to an entity which borrows the funds
for a defined period of time at a variable or commonly, fixed interest rate.

Government Securities fall under the category of debt securities and most of them are also
classified as fixed income instrument. The National Government through the Bureau of Treasury
issues debt securities known as Treasury bills (T-bills) and Treasury Bonds (T-bonds).
Treasury bills have maturities of one year or less while Treasury bonds or Treasury notes have
maturities longer than one year which could range from 2 to 25 years.

There are other government securities issued by government agencies aside from the Bureau of
Treasury such as the bonds issued by local government units (LGUs). The primary difference is
that these bonds are not backed unconditionally and are not direct and general obligations of the
National Government. Because of this difference, a higher rate of return is required compared to
treasury securities.

Corporate Debt Securities are debt instruments issued by corporations. They are in the form of
commercial paper and corporate bonds. Commercial papers are short-term instruments issued
by a corporation for their immediate needs. Corporate bonds are long term debt
instruments.

Corporate bonds are also traded like government securities using the Philippine Dealing
Exchange (PDEx) platform. Investors would need to transact with their dealer banks in order to
invest in these securities. Minimum purchase of bond is normally higher relative to stocks and
bank deposits. Clients may also view their bond’s performance online depending on which bank
they bought it from.

2. Alternatives to Fixed Income & Equity (Pooled Funds)

Instead of investing in specific securities, an individual may invest in the shares of mutual funds, units
in the Unit Investment Trust Funds (UITFs) offered by banks or in Exchange Traded Funds
(ETFs) traded in the stock exchange.
 a) Mutual Funds- are investments made up of a pool of funds collected from many investors for
the purpose of investing in stocks, bonds, and other similar assets. To access this type of
investment, go to an insurance company or a financial institution that offers mutual funds like
Philequity, Sun Life, and Manulife and sign the necessary account opening forms. As with
stocks, minimum amounts will be required to successfully open the account. Some of these
financial institutions also provide online access to monitor their mutual fund performance.

b) Unit Investment Trust Fund (UITF )- is similar to a mutual fund but is managed by banks. How
to access UITF? The same procedure as a mutual fund except that UITFs are accessed through
banks.

Investing in pooled funds avoids the transaction costs incurred in buying individual securities and
avoids the required time spent if one was to manage his own portfolio. Investment professionals
with the appropriate knowledge and skill also manage these pooled funds. However, numerous fees and
charges are levied against the investor for the management service rendered.

The initial price and returns derived from mutual funds and UITFs are based on the movement of the net
asset value (NAV) per share or per unit. Gains are incurred when the NAV per share of per unit
increases from the price a share or a unit was bought. Losses are incurred when the NAV per share or
per unit decreases.

Investments in ETFs incur gains and losses similar to how listed equity investment works. Currently,
only one ETF, First Metro Philippine Equity Exchange Traded Fund, Inc., is traded at the PSE.

3. Other Investment Assets

a) Currencies- generally accepted form of money, including coins and paper notes, which is
issued by a government and circulated within an economy (i.e. USD, Peso, JPY, EUR). How to
access this type of investment? Open a foreign currency/forex account (i.e. oanda, fxcm, cboe,
etc.) online. Minimum amount required for forex accounts varies and usually higher vs. stocks
and usually in US dollar. Investment can be monitored online.

b) Commodities- a basic good used in commerce that is interchangeable with other commodities
of the same type (i.e. gold, nickel, oil). Accessing this type of investment has the same
procedure as in Currencies.

c) Insurance- a contract (policy) in which an individual or entity receives financial protection or

reimbursement against losses from an insurance company (i.e. life insurance, educational plans,
Variable Universal Life Insurance). Variable Universal Life Insurance is a life insurance that
offers both death benefit and investment features. Just visit insurance companies directly to
avail of this investment.

d) Real Estate- land and any improvement on it (i.e. land, house and lot,
condominiums). To access this type of investment, contact or visit real estate companies
directly (i.e. Ayala Land, Megaworld, SM Prime, etc., or contact real estate brokers.

Investment Scams, on the other hand, usually involve getting you to put up money for a
questionable investment – or one that doesn’t exist at all. In most cases, you’ll lose some or all of your
money. Some common scams are: Advance fee scam, Boiler room scam, Exempt securities scam,
Forex scam, Offshore investing scam, Pension scam, Ponzi or Pyramid Scheme, Pump and Dump
Scam, Investment cold calls, Share promotions and hot tips, and many more. A sign of scam can be
‘High returns and low risk’, ‘hot tip or insider information,’ Pressure to buy now,’ or
‘Seller not registered to sell investments.’
Summary of the Types of Investments and Their Advantages and Disadvantages:

1. Fixed Income and Equity

2. Alternatives to fixed income and equities

3. Other investment assets

 Practice Makes Perfect

ARRANGE ME. Directions: Unscramble the letters to reveal the word(s) identified in the following
sentences. Write your answer on your answer sheet.

1. The ability of an asset to be converted into cash.

U T I L Y D I I Q

2. The general increase in prices.

I N O N A T I F L

3. The amount paid on a regular basis to the insurance company in return for the
insurance/protection provided.
A R U S I N E C N R P U I M E M

4. Distribution of the company’s income to its shareholders.

I D V I D S D E N

5. The process of investing in different kinds of assets to lessen exposure in market/price

volatility.
T I O N A C I F R S I E V D I

6. Money which is committed to earn a return over a period of time.

S M E N T E V N I T
 7. The uncertainty of returns.

S K R I

8. A debt security issued by the government that have maturities of one year or less.

S U R E T Y A R B L I L S

9. How price of an asset moves with respect to another asset.

R O C E L R A T I O N

10. This usually involve getting you to put up money for a questionable investment- or one
that doesn’t exist at all.

T S E I N V M E N T M A C S

Live It Out!

Performance Task 5: Assume that you have ₱1,000,000 on hand. Copy the table below and allocate
using percentages the 1M pesos that you have on the following investments.

Why have you chosen such allocation? What did you consider in choosing such allocations? Provide a
5-sentence justification for your answer.
 Learning Check!

MATCH ME! Directions: Match the investment asset in column A with its description in column B by
writing the capital your answer sheet.

Investment Asset Description

A. An investment that is made up of a
pool of funds collected from many
1. Bank Deposits
investors for the purpose of investing in
stocks, bonds, and similar assets.
B. It is a property consisting of land and any
2. Mutual Funds
improvements on it.
C. It a type of security that signifies
ownership in a corporation and
3. Real Estate
represents a claim on part of the
corporation's assets and earnings.
D. A contract (policy) in which an
individual or entity receives financial
4. Insurance
protection or reimbursement against
losses from an insurance company.
E. Money placed into a banking institution
5. Stocks
for safekeeping.

***END OF WORKSHEET 14***

 BUSINESS FINANCE
WORKSHEET #15

Lesson 15: Managing and Reducing Investment Risks

At the end of the lesson, you should be able to measure and list ways to minimize or reduce investment
risks in simple case problems

What’s New?

Risk management is the process of identification, analysis and acceptance or mitigation of

uncertainty in investment decisions. Risk is inseparable from return in the investment world.
(https://www.investopedia.com/terms/r/riskmana gement.asp). Putting your money into an investment is
always accompanied by a risk.

Brown and Reilly (2014) identified the major sources of risks as follows:

1. Business risk
2. Financial risk
3. Liquidity risk
4. Exchange rate risk
5. Country risk

Business risk is related to the nature of the company’s products and operating strategy. Companies with
stable sources of sales and earnings have relatively low business risk.

Financial risk refers to the risk created by the choice of capital structure—the financing mix of the issuing
company. A company usually funds its operation through debt and equity financing. As the debt portion
increases, financial risk increases.

Liquidity risk is the uncertainty that an investment can be converted to cash at a known price. The
existence of exchange facilities eases in liquidating an investment. If there is no ready market for the
investment, it is considered illiquid and a higher liquidity premium is required by investors. The presence
of many ready buyers and sellers reduces liquidity risk.

Exchange rate risk exists if the investment is denominated in another currency different from that of the
local currency of the investor. An additional uncertainty exists if the investor needs to liquidate the foreign
currency-denominated investment and convert it to Philippine peso, for example.

Country risk is associated with political and economic uncertainty of a particular business environment.
You can only entice investors to invest in countries with political stability if a higher rate of return is
expected.

With these sources of risks that an investor may encounter for his investment, here are the steps on how
to minimize or reduce risk on your investment.
 STEPS TO MINIMIZE OR REDUCE INVESTMENT RISKS

Source:https://www.clearrisk.com/risk-management-blog/bid/47395/the-risk-management-
process-in-5-steps

1. Identify Risks. The four main risk categories of risk are hazard risks, such as fires or injuries;
operational risks, including turnover and supplier failure; financial risks, such as economic
recession; and strategic risks, which include new competitors and brand reputation. Being able
to identify what types of risk you have is vital to the risk management process.

An organization can identify their risks through experience and internal history, consulting with
industry professionals, and external research. They may also try interviews or group
brainstorming.

2. Measure Risk. A risk map is a visual tool that details which risks are frequent and which are
severe (and thus require the most resources). This will help you identify which are very unlikely
or would have low impact, and which are very likely and would have a significant impact.
Knowing the frequency and severity of your risks will show you where to spend your time and
money, and allow your team to prioritize their resources.

3. Examine Solutions. Organizations usually have the options to accept, avoid, control, or transfer a
risk.

Accepting the risk means deciding that some risks are inherent in doing business and that the
benefits of an activity outweigh the potential risks.
To avoid a risk, the organization simply has to not participate in that activity.

Risk control involves prevention (reducing the likelihood that the risk will occur) or mitigation,
which is reducing the impact it will have if it does occur.

Risk transfer involves giving responsibility for any negative outcomes to another party, as in
the case when an organization purchases insurance.

4. Implement Solution. Once all reasonable potential solutions are listed, pick the one that is most
likely to achieve desired outcomes.

Find the needed resources, such as personnel and funding, and get the necessary buy-in. Senior
management will likely have to approve the plan, and team members will have to be informed and
trained if necessary.
 Set up a formal process to implement the solution logically and consistently across the
organization, and encourage employees every step of the way.

5. Monitor Result. Risk management is a process, not a project that can be “finished” and then
forgotten about. The organization, its environment, and its risks are constantly changing, so the
process should be consistently revisited.

Determine whether the initiatives are effective and whether changes or updates are required.
Sometimes, the team may have to start over with a new process if the implemented strategy is
not effective.

Risk Measure and Risk Reduction

• Risk Measure – Single asset

A basic risk measure for a single asset is the variance and standard deviation (square root of the
2
variance) of returns. The variance (𝜎 ) is computed as follows:

Where:
Rt = Return for a Particular Period
Rmean = Average return
n = Number of Periods

Computing the variance involves the following steps:

1. Get the mean.

2. Get the difference of each return and the mean.
3. Get the squared difference.
4. Add the squared difference.
5. Divide by the number of periods.
• Risk-Return Measure

Assets should be compared based on both risk and return. The coefficient of variation is a simple risk-
return measure to compare various assets. It is computed by dividing the standard deviation of returns
by the mean return.

Using our Stock A example, the coefficient of variation is equal to: Coefficient of variation = 0.0326 /
0.1504 = 0.21676

Based on this simple measure, investors should prefer assets with a low coefficient of variation.

• Risk Reduction

From a portfolio perspective, risk, as measured by the portfolio variance or standard deviation, can be
reduced by combining assets whose returns do not move in the same direction or at least do not move
perfectly together.

This will accomplish the same objective of minimizing risk for a given level of return. It is then the
objective of the investor to look for these assets, whose returns are not correlated, less correlated, or
better yet, negatively correlated.

It is recommended that an investor should not pull out his money in a single asset and diversify his
portfolio into various assets associated with differing industries and businesses. As they say, “Do not put
all your eggs in one basket.”
 Practice Makes Perfect

Write A if the statement is correct, and write B if otherwise. Write your answer on a separate sheet of
paper.

1. The lower the standard deviation is, the lower is the risk of the single asset
2. Volatility considered systematic investment and non-systematic investment.
3. Return on investment should be considered in analyzing risk.
4. Volatility is often calculated using variance and standard deviation
5. The standard deviation is equal to the square root of the variance.
6. Assets should be compared based on both risk and return.
7. Liquidity risk exists if the investment is denominated in another currency different from that of
the local currency of the investor.
8. Companies with stable sources of sales and earnings have relatively low business risk.
9. A company usually funds its operation through debt and equity financing.
10. Risk can be defined as the uncertainty of returns.

Live It Out!

Performance Task 6
Read carefully the situation below and answer the guide questions given. Write your answer in a clean
sheet of paper.

ABC Grocery Store is the number one store in the city, with total asset of 20 million. Its
operations last for 15 years. It has 25 employees which includes the manager. For the last
quarter, the manager notices that the number of sales decreases by 10% but the number of
inventories in and out remains the same. With the number of employees, there were five new
members who were hired few months ago.

Guide Questions:

a) What do you think was the problem of the organization? Do you think there was fraud
committed? Who committed the fraud? Defend your answer.

b) What type of risk is the store facing?

c) If you were hired by ABC Grocery Store to investigate, what steps are you going to take in order
to identify the cause of the problem?

d) What possible solution to the problem can you recommend to the manager to reduce or
eliminate the probability of fraud? Explain your answer.
 Learning Check!

Compute the mean return, variance and standard deviation of returns of Stock X based on the returns
of the 5-year period below. Write your answer on a separate sheet of paper.

Return

2015 16.25%

2016 19.50%

2017 13.80%

2018 25.50%

2019 9.20%

***END OF WORKSHEET 15***