603 - Investment and Portfolio Management

UNIT-1- Introduction to Investment (15%)

CONTENT OF CHAPTER
1.1 Basic Concept, objectives and characteristics of investment
1.2 Investment vs. speculation and Gambling
1.2.1 Investment vs. speculation
1.2.2 Investment vs. Gambling
1.2.3 Investment vs. speculation and Gambling
1.3 Investment decision making Process
1.4 Different investment alternatives and their risk & return profile

Prepared By:
MS. AMI MISTRY
VIDYABHARTI TRUST COLLEGE OF BUSINESS, COMPUTER-
SCIENCE AND RESEARCH, UMRAKH
1.1 BASIC CONCEPT, OBJECTIVE AND CHARACTERISTICS
OF INVESTMENT:
 Meaning of Investment:
 Investment means the investing of money.
 In Finance, the purchase of a financial product or other item of value with an
expectation of favorable future returns.
 Investment in finance means commitment of a person’s funds to derive future
income or appreciation in the value of their capital.
 Example: Share market, Gold
 Future income may be:
o Interest
o Dividend
o Premiums
o Pension Benefits
o Purchasing of shares/ debentures
o Post office saving certificates
o Insurance Policies
 Economic Meaning Of Investment:
 Investment refers to net addition to the economy’s capital stock with consists
of goods and services that are used in the production of their goods and
services.
 Formation of new and productive capital:
o New construction
o Plant and machinery
o Inventories

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 Investment may be defined as, “a commitment of funds under in expectation
of some positive rate of return”.
 It can be defined a, “a sacrifice of current money or other resources for future
benefits”.
 Examples:
o Lending money to another (interest)
o Purchasing of gold (value appreciation)
o Purchase of insurance plan (promised future benefits)

 Objectives of Investment:

Return
Liquidity
Risk

Tax OBJECTIVES Hedge

OF against
exemption INVESTMENT inflation

Income Safety
Growth

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1) Return:
Return refers to expected rate of return from an investment. Investor always
prefers high rate of return for his investment. Returns could be in the form of
dividend, interest, capital gain etc. Returns depend upon the factors such as
nature of the investment, the maturity period, stability of earnings etc.

2) Risk:
Minimizing the risk and maximizing the returns are the main objectives of any
investment. An investment whose rate of return varies widely from period to
period is risky than whose return that does not change much. Every investor
likes to reduce the risk of his investment by proper combination of different
securities.

3) Hedge against inflation:

The rate of return should ensure a cover against inflation. The rate of return
should be higher than the rate of inflation; otherwise the investor will have to
loss in real terms. Growth stocks would appreciate in their value and provide a
protection against inflation.

4) Safety:
While no investment option is completely safe, there are products that are
preferred by investors who are risk averse. Some individuals invest with an
objective of keeping their money safe, irrespective of the rate of return they
receive on their capital. Such near-safe products include fixed deposits, savings
accounts, government bonds etc.

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5) Growth:
While safety is an important objective for many investors, a majority of them
invest to receive capital gain, which means that they want the invested amount
to grow. There are several options in the market that offer this benefit. These
include stocks, mutual funds, gold, property, commodities, etc. It is important
to note that capital gains attract taxes, the percentage of which varies according
to the number of years of investment.

6) Income :
Some individuals invest with the objective of generating a second source of
income. Consequently, they invest in products that offer returns regularly like
bank fixed deposits, corporate and government bonds, etc.

7) Tax exemption:
Some people invest their money in various financial products solely for
reducing their tax liability. Some products offer tax exemptions while many
offer tax benefits on long-term profits.

8) Liquidity:
Many investment options are not liquid, this means they cannot be sold and
converted into cash instantly. However, some people prefer investing in options
that can be used during emergencies. Such liquid Instruments include stock,
money market instruments and exchange traded funds, to name a few.

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 Characteristics of Investment:

Return
Tax
shelter Risk

Stability
of Characteristics of
Safety
income Investment

Capital
growth Liquidity

Marketability

1) Return:
Return refers to expected rate of return from an investment. Return is an
important characteristic of investment. Return is the major factor which
influences the pattern of investment that is made by the investor, Investor
always prefers high rate of return for his investment. Returns could be in the
form of dividend, interest, capital gain etc. Returns depend upon the factors
such as nature of the investment, the maturity period, stability of earing’s etc.

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2) Risk:

It is one of the major characteristics of an investment. Risk refers to the loss of

principal amount of an investment. It refers to the possibility of incurring a loss
in a financial transaction. Risk is inherent in any investment. Risk and return
of an investment are related. The higher the risk, the higher is the return.

(i) Loss of capital

(ii) Delay in repayment

(ii) Non-payment of interest

(iv) Variability in returns

(iii) Non-payment of interest

(v) Variability in returns.

Risk of an investment depends on the following factors.

(i) Maturity period, greater the maturity period, larger the risk (ii) The lower
credit worthiness

(iii) Nature of the investment e.g. Equity shares carry higher risk and debt
instruments bond/debentures carry lower risk compare with equity.

3. Safety

Safety is another feature which an investor desires for his investments. Safety
implies the certainty of return of capital without loss of money or time. Every
investor expects to get back his capital on maturity without loss and without
delay. In other words Safety refers to the protection of investor's principal
amount and expected rate of return.

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 If investor prefers less risky securities, he chooses Government bonds. In case,
investor prefers high rate of return he will choose private Securities and Safety
of these securities is low.

4. Liquidity

An investment which is easily saleable or marketable without loss of money

without loss of time is said to be possess liquidity. Liquidity means that
investment is easily realizable, saleable or marketable. When the liquidity is
high, then the return may be low. For example, UTI units. An investor
generally prefers liquidity for his investments, safety of funds through a
minimum risk and maximization of return from an investment.

5. Marketability

Marketability refers to buying and selling of Securities in market,

Marketability means transferability resale ability of an asset, Securities are
listed in a stock market which are more easily marketable than which are not
listed. Public Limited Companies shares are more easily transferable than
those of private limited companies.

6. Capital Growth

Capital Growth refers to appreciation of investment. Capital growth has today

become an important characteristic of investment. Growth of investment
defends upon the industry growth.

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 7) Stability of Income

It refers to constant return from an investment. Another major characteristic

feature of the Investment is the stability of income. Stability of income must
look for different path just as security of principal. Every investor always
considers stability of monetary income.

8) Tax Shelter

Tax benefits are in the following three kinds:

(a) Initial tax benefits

(b) Continuing tax benefit
(c) Terminal tax benefit

(a) Initial tax benefit: It is the tax relief enjoyed by the investor at the time
of making the Investment.
(b) Continuing tax benefit: A continuing tax benefit represents the tax shield
associated with the periodic returns from the Investment.
(c) Terminal tax benefit: Relief from taxation when an investment is realized
or liquidated Ex: withdrawal from a public provident fund account is not
subject to tax.

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1.2 Investment vs. speculation and Gambling
 Difference between Investments vs. Speculation:

Investment Speculation
Meaning Investment refers to the While speculation in refers to
investing of money OR the the act of conducting a
purchase of an assets with the financial transaction that has
hope of getting return is called substantial risk of losing value
investment. but also holds the expectation
of a significant gain.

Basis of In investment the fundamental While speculation technical

decision factors i.e.; I preference of the charts & market psychology,
company evaluation. opinion market sentiment.

Time Horizon Generally, investment are long While speculation are for short
run. period.

Intent to profit In investment changes in value. While in speculation changes

in price.
Expected rate Moderate rate of return. High rate of return.
of return
Funds An investor uses his own A speculator uses borrows
funds. funds.
Behaviors of Conservative & cautions. Daring & careless.
participants
Stability of Investment offers stable Speculators incomes are
Income income. uncertain & erratic in nature.

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 Investment Speculation
Risk Factors Investment has low or Speculators involves high risk.
moderate risk.
Example Government bonds, Mutual Foreign currency, crypto
funds, Shares, etc. currency, derivative market.
Leverage An investor generally uses his Whereas a speculators
own funds. normally, goes for borrowed
funds.
Volume of The volume of a trade of an The volume of a trade of a
traders investor is generally smaller. speculators is generally larger.

Aim Wealth creation with stable To achieve huge profits by

returns. carrying out risky financial
transaction.

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 Investment vs. Gambling:

Investment Gambling
Planning Investment are carefully Whereas gambling on the other
throughout decisions which hand is unplanned & non-
involve calculated risk. scientific.

Time Horizon An investor has a relatively A gambler has a relatively

longer time horizon. short time horizon.

Risk An investor is generally risk It consists of tanking high

averse. returns but also for excitement.
Consistency of An investors expected return is Whereas in gambling returns
return consistent with underlying risk are too uncertain.
of the investment the returns are
moderate.

Safety Investor concentrates on safety Whereas the gambler is not

of funds invested. worried about the safety of
funds invested.

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  Investment vs. Speculation vs. Gambling:

Points Investment Speculation Gambling

Funds Own funds & Own funds or Have wealth &
availability looking to create borrowed money to looking to have
wealth. earn high return. fun.

Time For long term. For short term. Immediate.

Horizon
Basis of Analysis of News & sentiments in random
decision fundamentals of the market.
underlying assets &
company.

Risk Reasonable & Higher risk Very high risks &

moderate risk. ads of winning
are very less.
Returns Reasonable return High return however Depends upon
over a longer period over a long period of luck & odds.
of time in most of time, speculation do
the cases investment not earn on their
will earn profit. investment.
Stability of Stable uncertain No stability
income
Types of Cautions & Aggressive & high Ready to lose
investors conservation. risk. original
investment.
Vehicle Stock, bonds, real Stock, bit coin Lottery,
estate. racetrack.

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1.3 Investment decision making Process.

INVESTMENT POLICY:

The government or the investor before proceeding into investment formulates of the
policy the systematic functioning. The essential ingredients of policy are the
investible funds, objectives and the knowledge about the investment Alternative and
market.

Investible finds

The entire investment procedure revolves around the availability of investible funds.
The fund may be generated through savings or from borrowings. If the funds are
borrowed, the investors has to be extra careful in the selection of investment
alternatives. The return should be higher than the interest he pay. Mutual fund invest
their owner's money in securities.

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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 front of capital appreciation, whereas
the primary objective of the risk averse is the safety of the principal.

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 alternatives differ from each other.
Investment in equity is high yielding but has more risk than the fixed income
securities. The tax sheltered schemes offer tax benefits to the investors.

Investor should be aware of the stock market structure and the functions of the
brokers. The mode of operation varies among BSE, NSE and OTCEI. Brokerage
charges are also different. The exchanges about the stock exchange enables him to
trade the stock intelligently.

SECURITY ANALYSIS

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

scrutinized through the market, industry and company analysis.

Market analysis

The stock market mirrors the general economic scenario. 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 upward or downwards. The
investor can fix his entry and exit points through technical analysis.

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Industry analysis

The industries that contribute to the output of the major segments of the economy
vary in their growth rate and their overall contribution to economic activity. Some
industries grow faster than the GDP and are expected to continue in their growth.
For example the information technology industry has experienced higher growth rate
than the GDP in 1998. The economic significance and the growth potential of the
industry have to be analyzed.

Company analysis

The purpose of company analysis is to help the investors to make better decisions.
The company's earnings, profitability, operating efficiency, capital structure and
management have to be screened. 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 capital appreciation.

Valuation

The valuation helps the investor to determine the return and risk expected from an
investment in the common stock. The intrinsic value of the share is measured
through the book value of the share and price earing ratio. Simple discounting
models also can be adopted to value the shares. The stock analysis have developed
many advance models to value the shares. The real worth of the share is compared
with the market price and then the investment decision are made.

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Future value

Future value of the securities could be estimated by using a simple statistical

technique like trend analysis. The analysis of the historical behavior of the price
enables the investor to predict the future value.

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. The investor should decide how
best to reach the goals return with the securities available. The investor tries to attain
minimum return with minimum risk. Towards this end he diversifies his portfolio
and allocates funds among the securities.

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. There are several ways to diversify the portfolio.

Debt and equity diversification

Debt instruments provide assured return with limited capital appreciation. Common
stock provide income and capital gain but with the flavour of uncertainty. Both debt
instruments and equity are combined to complement each other.

Industry Diversification

Industries' growth and their reaction to government policies differ from each other.
Banking industry shares may provide regular returns but with limited stock
appreciation. The information technology stock yields high return and capital
appreciation but their growth potential after the year 2002 is not predictable. Thus,
industry diversification is needed and it reduces risk.
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Company Diversification

Securities from different companies are purchased to reduce risk. Technological

analysts suggest the investors to buy securities based on the price movement.
Fundamental analysis suggest the selection of financially sound and investor friendly
companies.

Selection

Based on the diversification level, industry and company analyses the securities have
to be selected. Funds are allocated for the selected securities. Selection of securities
and the allocation of funds and seals the construction of portfolio.

EVALUATION

The portfolio has to be managed efficiently. The efficient management calls for
evaluation of the portfolio. This process consists of portfolio appraisal and revision.

Appraisal

The return and risk performance of the security vary from time to time. The
variability in return of the securities is measured and compared. The developments
in the economy, industry and relevant companies from which the stock are bought
have to be appraised. The appraisal warns the loss and steps can be taken to avoid
such losses.

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 the components of the portfolio
periodically.

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1.4 Different investment alternatives and their risk & return profile
The investments avenues can be broadly categorized under the following heads.

1. Corporate securities

2. Deposits in banks and non- banking companies.

3. UTI and other mutual fund schemes.

4. Post office deposits and certificated.

5. Life insurance policies.

6. Provident fund schemes

7. Government and semi-government securities.

Discuss briefly the important investment avenues available to savers in India.

1. Corporate securities:
 Corporate securities are the securities issued by joint stock companies in
the private sector.
 These include equity shares, preference shares and debentures. Equity
shares have variable dividend and hence belong to the high risk-high
return category, while preference shares and debentures have fixed returns
with lower risk.

2. Deposits:
 Among the non-corporate investments, the most popular are deposits
with banks such as savings accounts and fixed deposits.

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  Savings deposits have low interest rates whereas fixed deposits have
higher interest rates varying with the period of maturity. Interest is
payable quarterly or half-yearly.
 Fixed deposits may also be recurring deposits wherein savings are
deposited at regular intervals.
 Joint stock companies also accept fixed deposits from the public. The
maturity period varies from three to five years. Fixed deposits in
companies have high risk since they are unsecured, but they promise
higher returns than bank deposits.
 Fixed deposit in non-banking financial companies (NBFCs) is another
investment avenue open to savers. NBFCs include leasing companies,
hire purchase companies, investment companies, chit funds, etc.
Deposits in NBFCS carry higher returns with higher risk compared to
bank deposits.

3. UTI and other Mutual Fund schemes:

 Mutual funds offer various investment schemes to investors. UTI is the
oldest and the largest mutual fund in the country. Unit Scheme 1964,
Unit Linked Insurance Plan 1971, Master Share, Master Equity Plans,
Master gain, etc. are some of the popular schemes of UTI.
 A number of commercial banks and financial institutions have set up
mutual funds. Recently mutual funds have been set up in the private
sector also.

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4. Post office deposits and certificate:
 The investment avenues provided by post offices are generally non-
marketable. Moreover, the major investments in post office enjoy tax
concessions also. Post offices accept savings deposits as well as fixed
deposits from the public.
 There is also a recurring deposit scheme which is an instrument of
regular monthly savings.
 Six-year National Savings Certificates (NSC) are issued by post offices
to investors. The interest on the amount invested is compounded half-
yearly and is payable along with the principal at the time of maturity
which is six years from the date of issue.
 Indira Vikas Patra and Kissan Vikas Patra are savings certificates
issued by post offices.

5. Life insurance policies:

 The Life Insurance Corporation (LIC) offers many investment schemes
to investors. These schemes have the additional facility of life insurance
cover.
 Some of the schemes of LIC are Whole Life Policies, Convertible
Whole Life Assurance Policies, Endowment Assurance Policies,
Jeevan Saathi, Money Back Plan, Jeevan Dhara, Marriage Endowment
Plan, etc.

6. Provident fund schemes:

 Provident fund schemes are compulsory deposit schemes applicable to
employees in the public and private sectors.

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  There are three kinds of provident funds applicable to different sectors
of employment, namely Statutory Provident Fund, Recognized
Provident Fund and Unrecognized Provident Fund.
 In addition to these, there is a voluntary provident fund scheme which
is open to any investor whether employed or not. This is known as the
Public Provident Fund (PPF). Any member of the public can join the
scheme which is operated by the post offices and the State Bank of
India.

7. Government and semi government securities:

 The government and semi-government bodies like the public sector
undertakings borrow money from the public through the issue of
government securities and public sector bonds.
 These are less risky avenues of investment because of the credibility of
the government and government undertakings.

*** THANK YOU***

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