Introduction To

Investment

Krupanidhi School of Management 30

DEFINITION:
 Investment is the current commitment of
money for a particular period of time in order
to derive anticipated future benefits that will
compensate for:
a) The time for which funds are committed.
b) The expected rate of Inflation.
C) The uncertainty of future payment.
 Investments refers to sacrifice of current
resources in anticipation of a future benefit.
 Investment involves commitment of certain
current cash flow in anticipation of an
uncertain future cash flows.
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DEFINITION:
 Investment involves employment of own
funds or borrowed funds on a real or
financial asset for a certain period of time in
anticipation of a return in future.
 Investment thus refers to postponement of
current consumption in anticipation of a
future benefit.
 The investor can be an Individual,
Government, Pension fund, or a
Corporation.
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Elements/ Features of
Investment
The following are the typical elements or features of an
investment:
 Return
 Risk
 Time Period
 Liquidity / Marketability
 Safety

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 Return: Investments are characterized by the
expectation of a return. In fact, investments are made
with the primary objective of deriving a return. The
return may be received in the form of yield (interest or
dividend) or capital appreciation (which is the
difference between the sales price and the purchase
price).
 Risk: Risk is inherent in any investment. This risk may
relate to loss of capital, delay in repayment of capital,
non-payment of interest, or variability of return.
Literally, while investments in government securities
and bank deposits are risk free, other investment
vehicles are more risky.

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 Safety: The safety of investment implies the certainty
of return, without any loss of money or time. Safety is
another common feature which an investor desires for
his investment.
 Liquidity: An investment which is easily marketable
without loss of value and time is said to liquid.

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 INVESTMENT ALTERNATIVES :
 Real Vs Financial.
 Real assets determine the productive or
economic capacity of the society
 Real assets includes assets like land,
building, machinery, furniture, knowledge
etc,
 where as Financial assets includes assets
like cash, bonds, shares, derivative
instruments etc.

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Real Vs Financial assets:
 Financial asset determines the means by which
individuals hold their claims on real assets.
 they don’t directly contribute to the productive
capacity of the economy. e.g. stocks and bonds
 Real assets appear only on the asset side of the
balance sheet
 where as Financial assets appear both on asset
side and liability side of Balance Sheet.

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Investment Companies
 These companies are financial
intermediaries that collect funds
from indivudual investors and invest
those funds in a potetially wide range
of securities or other assets.
 Investment companies are financial
intermediaries that sell shares to
public and invest the proceeds in a
diversified portfolio of securities
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 Investment Companies

 Pooling of assets is the key idea behind investment

companies.
 Each investor has a claim to the Porfolio established by
the investment company in proportion to the amount
invested.
 These companies thus provide a mechanism for small
investors to team up to obtain the benefits of large-
scale investing.

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 Investment Companies
These companies perform several important functions
for investors:
• Administration & record keeping: capital gains,
dividends and so on

• Diversification & divisibility :i.e. by pooling of assets,

investment companies enable investors to hold fractional shares of many
different securities. They can act as large investors, even if, any
individual share holder cannot.

• Professional management: Most, but not all, investment

companies have full time staffs of security analysts and portfolio
managers

• Reduced transaction costsBecause they trade large blocks

of securities, investment companies can achieve substantial savings on
brokerage fees and commissions.
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• While all investment companies pool the assets
of individual investors, they also need to divide
claims to those assets among those investors.
• Investors buy shares in investment companies,
and ownership is proportional to the number of
shares purchased.
• The value of each share is called the net asset
value (NAV). Net asset value equals assets
minus liabilities expressed on a per share basis:

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 Net Asset Value
NAV equals assets minus liabilities expressed on
a per-share basis:

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Example: Consider a mutual fund that
manages a portfolio of securities worth $120
million. Suppose the fund owes $4 million to
its investment advisors and owes another $1
million for rent, wages due and miscellaneous
expenses. The fund has 5 million shares.
Then, the net asset value is calculated as
follows:
Net Asset Value = $120 million - $5 million = $23 per share
5 million shares

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Types of Investment companies/Organizations
1. Managed Investment Companies
 Open-End
 Closed-End
2. Unit Investment Trusts
3. Other investment organizations
 Commingled funds
 REITs
 Hedge Funds

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1. Managed Investment Companies

 Here, securities in the portfolio are continually bought

and sold; there is active management of investment
company or fund by either the firm that organizes the
fund or an outside portfolio manager.
 There are two types of managed companies:
 Open-End
 Closed-End

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 Open-End (called mutual funds)
 More popularly referred to as a mutual fund.
 It continually stands ready to sell new shares to the
public and to redeem its outstanding shares on
demand at a price equal to an appropriate share of the
value of its portfolio, which is computed daily at the
close of the market.
• Open-end: shares redeemed, new shares
issued at NAV;
• shares outstanding change when new
shares are issued or old shares are
redeemed
• Priced at Net Asset Value(NAV)
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 A mutual fund has no limit on the size of the fund or
the number of shares outstanding.
 The value of a mutual fund share is called its net asset
value.
 Mutual funds are heavily regulated investment pools
registered with the SEC that are open to all investors.
 open for all the year

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Closed-end fund:
 In contrast to mutual funds, closed-end funds sell
shares like any other corporation and usually do not
redeem their shares.
 Shares of close-end funds sell on either an organized
exchange (e.g. NYSE) or OTC market.
 an investment company with a fixed number of shares
that are bought and sold by investors, only in the open
market.
 Investor's who wish to purchase closed-end funds
must pay a brokerage commission at the time of
purchase and again at the time of sale.
 The price of the share is determined by supply and
demand, so the price can fall below or rise above the
NAV per share. 30 19
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 2. Unit Investment Trusts:
• It is similar to closed-end fund in that it issues a fixed number of
ownership shares called unit certificates.
• They are sold and redeemed only by the issuing company, like
open-end funds.
• Unit trusts typically invest in bonds and differ in several ways
from open and closed end funds that specialize in investing in
bonds.
• Unit trust has a fixed termination date unlike open-end and
closed –end funds.
• There is little active management of a unit investment
trust because once established, the investment
(portfolio) is of fixed composition, and of uniform
assets. Hence, these trust funds are called
unmanaged.
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 3. Other investment organizations
• Not as organized as investment companies but
similar to them in function
A). Commingled funds: are partnerships of investors
that pool their funds
• Like open-end, they're trades at NAV.
e.g. money market fund, bond fund, common stock fund
often offered by Bank or insurance company
B).Real estate investment trusts (REITs): equity trust,
mortgage trust
-Like closed-end, issuing shares and investing in
real estates or mortgages
An investment fund selling shares and investing in real estate related
assets
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C). Hedge funds
• Like mutual funds but private partnership so
under minimal SEC regulation
• Hedge funds are private investment pool,
unregistered investment pools, open to a limited
number of accredited investors. (wealthy or
institutions)
• The goal of a hedge fund is providing consistent,
above-market returns while reducing the risk of
loss.

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 Hedge funds ≈ mutual funds that are free to pursue
any investment style
 Very little disclosure or regulation requirements
 Not required to maintain any particular degree
of diversification or liquidity
 Hedge fund managers have considerably more
freedom to follow various investment
strategies, or styles.

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 Security market
• A security is a document that gives the owner a claim on future
cash flows.
• A security may represent an ownership claim on an asset (such as a
share of stock) or a claim on the repayment of borrowed funds, with
interest (such as a bond).
• The document may be a piece of paper (such as a stock certificate
or a bond) or an entry in a register (which may, in turn, be a
computer record).
• A securities market is an arrangement for buying and selling
securities. It may be a physical location or simply a computer or
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 1. Money Market Securities

• Money market securities are short-term

indebtedness.
• By “short-term”, we usually imply an
original maturity of one year or less. The
most common money market securities
are:
• Treasury bills
• Commercial paper
• Negotiable certificates of deposit and
• Bankers’ acceptances.
• Repurchase agreement
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2. Capital Market Securities
• Capital Market: market where long-term
securities such as stocks and bonds are
bought and sold.
• The various capital market instruments used
by corporate entities for raising resources are:
• Preferred Shares
• Equity Shares
• Bonds (Both Corporate and Government)

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 Types of capital market
 Primary Markets
 Market for issuing a new security and distributing to
saver-lenders.
 the market in which new issues of securities are sold to
the public.
 This market is concerned with new issues. Therefore, the
primary market is also called NEW ISSUE MARKET.
 Secondary Markets
 The market in which the buying and selling of the
previously issued securities is done.
 Market where existing securities can be exchanged
 New York Stock Exchange
 American Stock Exchange

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 Third market
 There is another market place, It is called the over-the-counter
market or OTC market.
 The OTC market refers to all transactions in securities that are
not undertaken on an Exchange. Securities traded on an OTC
market may or may not be traded on a recognized stock
exchange.
 OTC market is an important alternative to exchanges and measured
in terms of the total volume of trading, has become much larger than
the exchange-traded market.
 It is a telephone- and computer-linked network of dealers. Trades
are done over the phone and are usually between two financial
institutions or between a financial institution and one of its clients.

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 Equities market
Common stock: Represents ownership in a corporation.
 A part owner receives a prorated share of whatever is left
over after all obligations have been met in the event of a
liquidation.
 Variable dividends, based on company’s profits.
 Preferred stock: The dividend is usually fixed and must
be paid before any dividends for the common shareholders.
In the event of a liquidation, preferred shares have a
particular face value.
 These shares carry a fixed return in the form of dividend.
 They have preference over equity shareholders on payment of
dividend and on repayment of Capital.

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Derivative Market
 A derivative security is a security whose value depends
on the values of other more basic underlying securities.

 In recent years, derivative securities have become

increasingly important in the field of finance.

 The derivative securities are also known as contingent

claims.

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Forward contracts
 Forward contract is relatively a simple derivative. It is an
agreement to buy or sell an asset at a certain future
time for a certain price.
 A forward contract is traded in the over-the-counter
market—usually between two financial institutions or
between a financial institution and one of its clients.
 It can be contrasted with a spot contract, which is an
agreement to buy or sell an asset today.

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Futures Contracts
 A futures contract is an agreement between two parties
to buy or sell an asset at a certain time in the future for
a certain price.
 Unlike forward contracts, futures contracts are normally
traded on an exchange.
 To make trading possible, the exchange specifies certain
standardized features of the contract.

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Futures versus Forward Contracts
A forward contract is a non standardized agreement to transact involving
the future exchange of a set amount of assets at a set price
A futures contract is a standardized exchange traded agreement to transact
involving the future exchange of a set amount of assets for a price that is
settled daily. Forward and futures contracts are differ on the ff. points:

FORWARD FUTURES
Traded on over the counter market Traded on an exchange
Not standardized Standardized
Settled at end of contract Settled daily
Delivery or final settlement usual Usually closed out prior to maturity
Some credit risk / counterparty risk Virtually no credit risk

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 Options
 An option is the right to either buy or sell
something at a set price, within a set period of
time
 Call option/ call – when the option grants the buyer the
right to purchase the underlying from the writer or the
seller.
 Call option gives the holder the right to buy the
underlying asset by a certain date for a certain price.
 Put option/ put – when the option buyer has the right to
sell the underlying to the writer.
 Put option gives the holder the right to sell the underlying
asset by a certain date for a certain price.

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The Bond Market
 the word ―bond‖ means contract, agreement, or
guarantee.
 an investor who purchases a bond is lending money
to the issuer, and the bond represents the issuer’s
contractual promise to pay interest and repay
principal according to specified terms.
 The bond market is a financial market where the
participants buy and sell debt securities.
 The bond market is also differently known as the
debt, credit or fixed income market.

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 There are different types of bond markets based on the
different types of bonds that are traded. They are:
 Corporate,
 Government and agency,
 Municipal,
 Bonds backed by mortgages & assets,
 Collateralized Debt Obligation.

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 Types of Orders:
 When investors place orders to buy or sell securities, they
expect their instructions to be
 precisely understood by the people involved in processing the
order. A number of standard
 packets of instructions are used in the brokerage business to
aid in this process.


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 1. Market Order:
 The most common type of order is the market order. With this
order, the investor trusts the
 fair pricing function of the marketplace. The broker is
to buy or sell at the best price
 prevailing at the moment. The key element of a
market order is that the order is to be
 executed as soon as possible.
 Market orders are to be executed as soon as possible after
reaching the exchange floor.
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 2. Limit Order:
 Sometimes an investor is not willing to trade at the market price, preferring
to set his or her
 own price and not trade until that price is obtainable. Limit order must
specify a price and a
 time limit. The time limit is most commonly either for the day or good till
canceled (GTC).
 Day orders expire at the close of business if they are not executed. GTC
orders remain open
 either until they are executed or the investor cancels them. Limit orders are
useful, but they
 should be used reasonably. A limit order with a limit price distant from the
prevailing
 market price is said to be away from the market.
 Limit order must specify a price and a time limit.

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 3. Stop Order:
 A Stop Order specifies a price and time limit, just like a limit order. The difference is that a
 stop order is only executed if a specified price, called the stop price is touched.
 Stop orders become market order when the stop price is reached. Therefore, it is possible for
 the actual sales price to be different from the stop price. The most important use of a stop
 order is to protect a profit and minimize losses. There is no cost to placing a stop order or
 raising the stop price; you only pay a brokerage commission when a trade occurs.
 Moving a stop up behind a rising stock is called using a crawling stop order. The question
 of where to place the stop price is a difficult one. If the stop is too far away from the current
 market price, an investor risks absorbing larger losses or giving up a good portion of any
 gains. Set too close to the current price, random movements across the bid-ask spread might
 trigger the stop in the absence of an adverse price movement.

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 A recent article in the Journal of Portfolio Management suggest a methodology whereby the
 investor sets a stop based on the volatility of the underlying asset, using a standard deviation
 of returns as a decision-making aid.
 Stop orders become market order when the stop price is reached.
 The most important use of a stop order is to protect a profit.
 Other Orders:
 Although much less common than the three discussed so far, a number of other types of
 orders might be placed.
 • One cancels the others
 • All or none
 • Fill or kill

 . Stop limit
 • Market if triggered order (MIT)
 • Good till cancel (GTC)

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END OF
CHAPTER
ONE
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