MF0010-Unit-01-Investment – A Conceptual Framework Unit-01-Investment – A Conceptual Framework
1.2 Real Asset Vs Financial Asset
1.3 Meaning of:
1.4 Modes of Investment
Security form of Investment
Non-Security form of investment
1.5 Characteristics of Investment
1.6 Investment & Speculation
Investment & Gambling
1.7 Investment process
1.8 Common Errors in Investment Management
1.9 Qualities of a Smart Investor
1.11 Terminal Questions
Investment is a process of sacrificing something now for the prospects of gaining something in the future. Investment means conversion of cash or money into a monetary asset or a claim on future money for a return.
you should be able to:
· Explain the meaning of real asset and financial Asset
· Define investment.This subject deals with various investment avenues that are available in the financial environment. mutual fund operations and the behavioral aspects of an investor
In this unit. the difference between investment and speculation and between investment and gambling. you will learn about with the meaning of various terminologies. security analysis and portfolio management
· Explain different modes of investment
· Explain various characteristics of investment
· Differentiate between investment and speculation and between investment and gambling
· List the investment process
. how to evaluate a security. You will learn the steps involved in the investment process.
After going through this unit. how fundamental and technical analysis of the security is made. efficient market hypothesis. common errors in investment management and qualities that are essential for successful investment. characteristics of investments. security. modes of investments.
The productive capacity is the function of the real assets of the economy which could be in the form of land. debentures instrument per se do not represent a society’s wealth. knowledge and machines that are used to produce goods and services. bonds.
On the other hand.· Analyze common errors in Investment Management
· Identify the qualities of a Smart Investor
Financial assets facilities transfer of funds from millions of individual investors to funds starved enterprise.2. They do not directly contribute to the productive capacity of the economy but indirectly facilitate in the wealth creation.2 Real Asset and Financial Assets
The material wealth of a society is determined by the productive capacity of its economy. The value of the financial asset derives from and depends on the value of the underlying real asset of the firm. building. a financial asset which represents various financial instruments such as shares.1 Difference between Real Asset and Financial Asset Real Asset
Appear only on the asset side of the balance sheet
Always appears on both assets side and liabilities of the balance sheet
The funds that you invest come from savings or from borrowing money or by liquidating assets already owned by you. When you invest your money in a fixed deposit. because you think its value will appreciate over a period of time.
It is created and destroyed in the ordinary course of business
Self Assessment Questions:
1. The value of the financial asset derives from and depends on the value of the __________________of the firm. we expect to enhance our future consumption possibilities.
An investment is a sacrifice of current money or other resources for future benefit. stock or mutual fund you do so.
1.It is destroyed only by accident or by wearing out overtime. ________ do not directly contribute to the productive capacity of the economy. The two key factors that determine
.3 Meaning of Investment:
Investing is committing your funds to one or more assets that will be held over some future time period.
2. By foregoing consumption today and investing the savings.
3. It denotes conversion of cash or money into a monetary asset or claim on future money for a return. State true or false: Real asset is created and destroyed in the ordinary course of business.
bonds. debenture. These combinations may be of various asset classes like equity. debt corporate debentures. bonds.
Securities Contract Regulation Act has defined the security as ‘Inclusive of shares. changes that may take place in combination with other securities due to interaction among themselves and the impact of each one of them on others. debenture stock or any other marketable instruments of a like nature in or any other debenture of a company or body corporate.investment decisions are return and risk which are dealt in subsequent units
Securities are financial assets in various categories with different characteristic. It includes all rights and interest in them including warrants and loyalty coupons. stocks.
A Portfolio is a combination of financial securities or other assets with different risk-return characteristics. the government and semi-government body etc’. money market instruments etc. money market instruments. scripts. warrants. Securities take the form of shares. derivatives etc.
Portfolio analysis is an analysis of the risk – return characteristics of individual securities or assets in the portfolio. A portfolio is built out of the wealth or income of an investor over a period of time with a view to suit his risk and return preference.
Portfolio is the combination of assets held by the investors.
The factors that determine investment decisions are _______ and __________. The return on the portfolio is the weighted average of return of individual stocks and the weights are proportioned to each stock’s percentage in the total portfolio. selection of securities.
The traditional portfolio theory aims at the selection of such securities that would match with the asset preferences. forecast of the share price in the future and estimating the intrinsic value of a security.
Self Assessment Questions
4. Intrinsic value is derived by forecasting the future cash flows of the security both annual cash flows (dividends/interest) and terminal value (redemption value) of the security.
Modern Portfolio theory focuses on maximization of return or minimization of risk which would result in optimum returns. needs and choices of the investor. revision. financial performance and also on risk return analysis.
Security analysis is based on fundamental analysis of a security like understanding the strength and weaknesses of the firm.
Portfolio analysis includes portfolio construction.Security analysis involves the projection of future earnings. evaluation and monitoring of the performance of the portfolio on a regular basis.
5. gathering information on promoters’ track record. The risk taking ability of the investor are only initial factors for investment decision and that continuous risk return analysis is the basis for optimization of returns. The return on the portfolio is the ____________________ of return of individual
A Portfolio is a combination of financial securities with different __________________.stocks. provide interest for using the funds and to return back the invested amount on maturity. __________ are combination of assets held by the investors.
Security forms of investment are those instruments which are transferable and traded in any organized financial market. The various avenues for investment ranging from riskless to high risk investment opportunities consist of both security and non-security form of investment. This receipt is a liability to the bank as the bank has to safe guard the investment.
6. This document also outlines the rights of the investor and sets conditions under which the investor can exercise his or her rights.
. As an investor you have a wide variety of investment alternatives available to choose
Marketable / Security form of investments:
The term ‘Security’ is generally used for those documents evidencing liabilities of the issuer.4 Modes of Investment
There are different types of securities conferring different sets of rights on the investors and different conditions under which these rights can be exercised. you are issued a document called Fixed Deposit Receipt or Certificate. When you buy a financial instrument say fixed deposit from a bank.
The issue of equity shares could be in the form of initial public offer. corporate debt instrument is referred as debentures although they are secured. growth shares.Equity Shares:
Equity shares represent ownership capital. These bonds are called gilt edged securities. In India.
Government bonds are issued by Central and State Governments. which specifies the detail of the issue such as par value of the bond. These are dealt in detail in the later units. bonus issue. There are different types of bond – Straight bonds. rights issue. bonds with embedded options. The issuer of a bond promises to pay a stipulated payment (interest and principal) to the bond holder. maturity period. The important money market instruments are:
a) Treasury Bills
. Floating rate bonds. commodity linked bonds etc. maturity date. Bond indenture is a contract between the issuer and the bond holder.
Internationally. a secured corporate debt instrument is called a corporate bond while an unsecured corporate debt instrument is called a corporate debenture. its coupon rate. call/put options etc. income shares. Zero coupon bonds.
Money Market Instruments: Debt instruments which have a maturity of less than one year at the time of issue are called M. preferential allotment and private placement.
Investors has a choice to select equity shares which are broadly differentiated as blue chip shares. An equity shareholder enjoys both ownership stake and residual interest in income & wealth.M Instruments. cyclical shares and speculative
Bonds/Debentures: Bonds represent long-term debt instruments.
There are three broad types of mutual fund schemes.b) Commercial paper
c) Certificate of deposits
d) Repurchase Agreements – Repos & Reverse Repos
Mutual Funds: Mutual funds are also known as indirect investments. Policies that provide protection benefits are designed to protect the policy holders from the financial consequences of unwelcome events such as death/long term sickness/accidents/disability etc.
1) Equity schemes
2) Debt schemes
3) Balance schemes
Non Security form of financial Investment:
Non security form of investments are neither transferable nor traded in any organized financial market
Life Insurance Policies: Life insurance may be viewed as an investment which suffices the protection and savings needs of an investor.
. It is an alternative route of buying equity shares or fixed income securities through various schemes floated by mutual funds companies.
The interest rate depends upon the tenure. Term assurance policy. retirement planning or repayment of a loan.
Bank deposits are the simplest and most common form of investment. Also loans can be raised on the fixed deposit certificates.
The important types of insurance policies in India are Endowment assurance policy. post office time deposit account. savings account and fixed deposit account. Some are pure savings schemes. Monthly income schemes.
Corporate Fixed Deposits
Certain large and small corporates raise funds through fixed deposits form
Post office Accounts
There are various types of accounts namely post office savings account. There are various kinds of deposit accounts: current account. while others are tax savings schemes.Policies that are designed as savings contracts allow the policyholders to build up funds to meet specific investment objectives such as income for a particular event.100000 per depositor of a bank. The deposit made in current account does not earn any interest while deposit made in savings account and fixed deposit accounts earn interest. National Savings Certificates. Deferred Annuity and Whole life policy. Kisan Vikas Patra. Bank deposit enjoys high liquidity due to premature withdrawals. Money back policy. Unit linked Plan.
Deposit Insurance Corporation provides guarantee to all deposits in schedule bank up to Rs.
Employee Provident Fund Scheme
Employee Provident Fund is an important component of savings for a salaried person.
. The investment period is 15 years and the minimum deposit is Rs100 per year and the maximum permissible deposit per year is Rs. __________ represent long-term debt instruments. The balance in provident fund account is fully exempt from wealth tax and it is not subject to attachment under any order or decree of a court. the contributions made by the employee is eligible for tax deductions under Sec 80C. Individuals and HUFs can invest in this scheme.The deposit earns a compounded interest rate of 8 percent per annum which is totally exempt from tax.70000.
Self Assessment Questions:
8. While fixed deposits mobilized by manufacturing companies are regulated by Company Law board and fixed deposit mobilized by finance companies are regulated by Reserve bank of India. The provident fund contribution earns compound interest rate that is totally exempt from taxes. The interest rates on company deposits are higher than those on bank fixed deposits. While the contribution made by the employer is fully tax exempt. Each employee has a separate provident fund account in which both the employer and employee are required to contribute a certain sum of money on a monthly basis.
Public Provident Fund Scheme
This scheme of post office is the most attractive investment option.the public. A manufacturing firm can mobilize up to 25 percent of its net worth in the form of fixed deposit from public and an additional 10 percent of its net worth from its shareholders. Deposits in a PPF account is eligible for tax concession under Sec 80C.
b. These features should be consistent with the investor’s general objectives. This change in wealth can be either due to cash inflow (annual income in the form of dividends/interest) or caused by a change in the price of the asset (capital appreciation/depreciation)
2. Risk: Risk is the likelihood that your investment will either earn money or lose money. is risk-free.5 Characteristics of Investment:
While choosing specific investment. Marketability: Marketability of an investment is measured on various parameters such as:
a. Most prominent features are:
1. whether domestic or international.
3. Return on investment is the change in the wealth resulting from this investment. No investment. The transaction cost of buying and selling an instrument is maintained low
. the investors will need to know the features of investment.
1. How quickly the instrument can be transacted ie.9. That is a fact you should not ignore. Even money lying securely in a savings account is at risk from inflation. can be bought or sold. we defer current consumption in order to add to our wealth so that we consume more in the future. It is the degree of uncertainty about your expected return from an investment. Rate of Return – When we invest. Fixed deposits mobilized by manufacturing companies are regulated by ___________
10. including the possibility that some or all of your investment may be lost. The investment period of PPF scheme is ________.
Convenience: It refers to the ease with which the investment can be bought or sold in the market. ______ is the likelihood that your investment will either earn money or lose money. Tax Shelter: Tax planning is essential for those investors who are in high tax bracket.
12. The price change between two successive transactions is negligible. How quickly the instrument can be transacted relates to ___________ feature of investment.
c) Terminal tax benefit refers to relief from taxation when an investment is realized on maturity or when it is sold. continuing tax benefit and terminal tax benefit.
b) Continuing tax benefit refers to the tax shield is associated with period returns from the investment. ___________ refers to relief from taxation when an investment is realized on maturity or when it is sold.
a) An initial tax benefit refers to the tax relief enjoyed at the time of making the investment.c. Tax benefits are of three forms – Initial tax benefit.
Self Assessment Questions:
5. Blue chip stocks can be bought and sold very quickly due to high liquidity while ‘Z’ category stocks cannot be transacted quickly thereby causing anxiety to the investors.
Gambling creates risk without expectation of economic benefit. unlike gambling. Example of speculation: Buying an IPO of a stock on the first day. is not based on random outcomes. random outcomes. leading to quick profit. promises safety of principle and an adequate return. makes a distinction between speculation and investing – “An investment operation is one which. But that is where the similarities end. with the hope that you might win money. Speculation. you would take away profits in the long run.”
Speculation occurs when an asset is purchased with the hope that price will rise rapidly. Gambling is putting money at risk by betting on an uncertain outcome.
Investing is not gambling. if you stay invested long enough in the stock market. Gambling is taking risk for no purpose other than the enjoyment of the risk itself. rather.
. because the acquired risk is higher than average. The outcome is not based on an economic endeavor. However. you are sure to lose money.1. In speculation. Speculation is undertaken despite the risk because there is a favorable risk-return tradeoff.
Investment and Gambling
Both investing and gambling require money and both require you to calculate the odds on a given ‘bet’ and you are taking risk. Operations not meeting these requirements are speculative. Speculators make informed decisions before choosing to acquire the additional risks. If you stay at the gambling table long enough in a casino.
Speculation should not be considered as a form of gambling. but. However. upon thorough analysis.6 Investment and Speculation
Benjamin Graham in his book ‘Security Analysis’. and you’re betting on the continued growth and success of the economy. hoping to sell it at a higher price within a short span of time. speculation cannot be categorized as a traditional investment. The risks of investments can be managed so that the odds are in your favor. significant risks are taken for obtaining quick gains.
and when the investment should be made. Such a group of securities is called a portfolio. __________ occurs when an asset is purchased with the hope that price will rise rapidly. the investment objectives should be stated in terms of both risk and return. leading to quick profit. with the hope that you might win money
1. Setting Investment Policy
This initial step determines the investor’s objectives and the amount of his investable wealth.
This step concludes with the asset allocation decision: identification of the
.7 The Investment Process
It is rare to find investors investing their entire savings in a single security.
15. how extensive the investment should be. ____________ is putting money at risk by betting on an uncertain outcome.Self Assessment Questions I
14. they tend to invest in a group of securities. Most financial experts stress that in order to minimize risk. Instead. Since there is a positive relationship between risk and return. an investor should hold a well-balanced investment portfolio. The investment process describes how an investor must go about making decisions with regard to what securities to invest in while constructing a portfolio. This is a procedure involving the following five steps:
While setting the investment policy.
Passive Management is the process of managing investment portfolios by trying to match the performance of an index (such as a stock market index) or asset class of securities as closely as possible. years. An investor with a longer time horizon may feel more comfortable with a riskier or more volatile investment because he can ride out the slow economic cycles and the inevitable ups and downs of the markets.
Risk Tolerance – Risk tolerance is an investor’s ability and willingness to lose some or all of his original investment in exchange for greater potential returns.potential categories of financial assets for consideration in the portfolio that the investor is going to construct. The conservative investors keep a "bird in the hand. such as stocks. based upon research.
Active Management is the process of managing investment portfolios by attempting to time the market and/or select ‘undervalued’ stocks to buy and ‘overvalued’ stocks to sell. This
Time Horizon – The time horizon is the expected number of months. A conservative investor. by holding all or a representative sample of the securities in the index or asset class. investigation and analysis. passive management). or decades that an investor will be investing his money to achieve a particular financial goal. or one with a high-risk tolerance. An aggressive investor. an investor who is saving for his teen-aged daughter’s college education would be less likely to take a large risk because he has a shorter time horizon.
The asset allocation that works best for an investor at any given point in his life depends largely on his time horizon and his ability to tolerate risk. tends to favour investments that will preserve his or her original investment. the investor also selects the portfolio management style (active vs. or one with a low-risk tolerance. By contrast. is more likely to risk losing money in order to get better results." while aggressive investors seek "two in the bush. bonds and cash. Asset allocation involves dividing an investment portfolio among different asset categories.
Instead. it relies upon market trends to ascertain investor sentiment to predict how a security will perform.portfolio management style does not use market timing or stock selection strategies. assets and liabilities. Unlike fundamental analysis. management. It scrutinizes the issuer’s income and expenses. Diversification aims at constructing a portfolio in such a way that the investor’s risk is minimized.
3. as well as determining the proportion of the investor’s wealth to put into each one. In other words. Selectivity refers to security analysis and focuses on price movements of individual securities.
Technical analysis is a method used to evaluate the worth of a security by studying market statistics. Portfolio Construction
This step identifies those specific assets in which to invest. Security analysis involves examining a number of individual securities within the broad categories of financial assets identified in the previous step. timing and diversification issues are addressed. technical analysis disregards an issuer’s financial statements. it focuses on the ‘basics’ of the business.
Fundamental analysis is a method used to evaluate the worth of a security by studying the financial data of the issuer. how does an investor select which securities to purchase. Security analysis is done either using Fundamental or Technical analysis (both have been discussed in subsequent units). Performing Security Analysis
This step is the security selection decision: Within each asset type.
2. Here selectivity. Timing involves forecasting of price movement of stocks relative to price movements of fixed income securities (such as bonds). One purpose of this exercise is to identify those securities that currently appear to be mispriced. identified in the asset allocation decision. and position in its industry.
as objectives might change and previously held portfolio might not be the optimal one.
4. Portfolio Revision
This step is the repetition of the three previous steps.
Maintain pre-determined selections
Try to track a well-known market index like Nifty.The following table summarizes how the portfolio is constructed for an active and a passive investor. Portfolio performance evaluation
This step involves determining periodically how the portfolio has performed
_____________________step involves determining periodically how the portfolio has performed over some time period (returns earned vs.8 Common Errors in Investment Management
When investment mistakes happen. _____________ refers to security analysis and focuses on price movements of individual securities
18. political. or due to misconceptions about how securities react to varying economic. and future income.
1. Investment decisions should be made with an investment plan in mind. but they generally happen because of the clouding of the investor’s judgment by the influence of emotions. and there is no place in a wellmanaged plan for speculations and “hot picks”. Investing is a goal-oriented activity that should include considerations of time.
Self Assessment Questions
16.over some time period (returns earned vs. money is lost. _________________ is a method used to evaluate the worth of a security by studying the financial data of the issuer. cool and rational head. due to the misunderstanding of basic investment principles. A well-thought out investment plan does not need frequent adjustments. and avoid these common investment mistakes:
· Not having a clearly-defined investment plan. Mistakes can occur for a variety of reasons. The investor should always keep a calm. and fear-driven circumstances. risks incurred).
17. risks incurred).
that does not fit their investment plan. The investor may have the “unwilling-to-pay-the-taxes” problem little realizing that the investment may ultimately end up as a realized loss on the tax return. Index Funds. Neither of these is good news for the health of an investment portfolio. and make drastic rather than measured adjustments. and they stick to it: It is very easy to be tempted by a tip about a hot stock that is reported in all the financial papers. Commodities. Consequently.
1. They look
. Such investors are likely to become confused and indecisive. Options. they buy every new product or service that comes along and catches their fancy. Hedge Funds. etc. Profits that are not realized are just book profits.e. Investing should always be regarded as a long-term activity and the investor should have this in mind before adjusting his portfolio.
· Investors tend to fall in love with securities that rise in price and forget to book their profits. But this is not the way that smart investors make money. leading to "paralysis by analysis".
· Investors often overdose themselves on information. it is also true that he must not become so blinded by the beauty of unrealized gain that he forgets the basics of prudent investing. While one should not be in a hurry to realize his profits.
· Investors are constantly in search of a shortcut or gimmick that will provide them instant success with a minimum of effort. Their portfolios become a mixture of Mutual Funds. the “get-rich-quick pick” syndrome. change direction frequently. i. A narrow focus on information which has a bearing on the investment is a much more productive means of fact-finding. Aggravating this problem for the investor is his inability to distinguish between genuine research and sales pitch of the sale side analyst. they may disappear when the market goes down.9 Qualities of a Smart Investor
Smart investors have a plan for investing.· Investors become bored with their plan or the rate of growth too quickly.
If they don’t understand a particular type of security. Smart investors understand this. they invest a part of their funds in securities with a growth potential (like stock and mutual funds).10 Summary
· Investing is committing one’s funds to one or more assets that will be held
. They gather as much information as they can and then invest in assets that are appropriate for their plans. successful investors know how to protect their gains. Similarly. they must not be emotional towards their investment. They only buy securities that they have researched or that someone they trust has recommended. If an investment has consistently lost money. Second. They generally use two methods to do this. or how badly an investment has performed recently. They don’t expect instant growth. They don’t jump in and out of investments in an effort to time the market. they keep adding to their investment principal regularly. they don’t try to wait to recoup their losses.at their goals. they know that they must keep their money constantly growing.
1. if an investment has appreciated phenomenally. that they know about and that they are comfortable with. selling at the right time is just as important as buying. time frame and knowledge of the markets to chart a plan that suits their needs.
Smart investors invest consistently: To succeed year after year. and therefore do not get excited about the daily ups and downs of the market. if they are 40 years old and have twenty years until retirement. they will not buy it. they are not disappointed by temporary setbacks in the market.
Smart investors are not emotionally tied to their investment positions: They know that to be successful. No matter how attractive an investment looks.
Smart investors are patient: It often takes time for a good investment to show results. For example. they implement a 20-year investment plan. and they are able to sell it when the time is right. They know that it is necessary to cut losses and move ahead. They stay with their investment plan. They are aware that no investment will move up forever. They understand that success is a long-term affair and therefore patience is required. First.
· The investment procedure involves the following five steps:
.Evaluate the performance of portfolio
· Smart investors have a plan for investing and they stick to it.
. They invest consistently and wait patiently for gains.Perform security analysis
· Investment involves risks.Set investment policy
. promises safety of principle and an adequate return.
· An investment operation is one which. Operations not meeting these requirements are speculative. an investor should hold a well-balanced investment portfolio.
· Investment differs from gambling and speculation.over some future time period. They are not emotionally tied to their investment positions.Construct a portfolio
. In order to minimize risk.Revise the portfolio
. upon thorough analysis.
Explain the meaning of investment. Differentiate between investment and speculation and between investment and gambling
1. Explain the modes of investment
3. Financial assets
2. security analysis and portfolio management. Explain the characteristics of investment
4. What are the common mistakes made in investment management?
7. security. Describe the investment process
6.1. Explain the qualities of a smart investor.11 Terminal Questions
1.12 Answers to SAQs and TQs
2. Underlying real asset
7. 15 years
11. Risk and return
5. Company Law Board
. Risk return characteristics
8. Terminal tax benefit
15. Weighted average
18. Refer Unit 1.9
About the Author
4. Refer Unit 1.7
3. Refer Unit 1. Refer Unit 1. Refer Unit 1. Portfolio Performance Evaluation
Answers to TQs:
5. Refer Unit 1. Fundamental analysis
7. Refer Unit 1.16.
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