Unit I

Investment
Investment-Meaning
The Purchase of a financial product or other item of value with an expectation of favorable
future return. In general terms, investment is the application of money for earning more
money.
Or

“Investment is commitment/application of one’s funds to one or more assets that will be

held over some future time period.”
Or

“Money that is invested with an expectation of profit”

”
 Investment -Definitions
According to finance, -
”The practice of investment refers to the buying of a financial product
or any valued item with an anticipation that positive returns will be
received in the future. “

According to business theories, -

”Investment is that activity in which a manufacturer buys a physical
asset, for example, stock or production equipment, in expectation
that this will help the business to prosper in the long run. “

Finance professionals define-

“An investment as money utilized for buying financial assets, for
example stocks, bonds, bullion, real properties, and precious
items.”

According to economics,-
“Investment is the utilization of resources in order to increase income
or production output in the future. Example-An amount deposited
into a bank or machinery “
Characteristics of an Investment
 Objectives
⚫ Capital Appreciation(Long-term performance)
⚫ Current/Regular Income (target return )
⚫ Liquidity
⚫ Security(Safety )
⚫ Tax Planning
⚫ Risk management
⚫ Time value of Money(Capital Preservation )

Examples-real-estate properties(like land) ,bonds, Equity shares,

T-Bills, Fixed Deposit, Mutual fund, Commodities(like
Gold),Insurance, PPF
Why Investment?????
Need and Importance of Investment
⚫ To target investor’s objective
⚫ Increasing rates of taxation /For availing Tax benefits
⚫ To assure Stability of income
⚫ To earn regular income/ Larger incomes
⚫ To minimize Risk
⚫ To obtain Time value of Money(High rate of inflation)
⚫ For Assuring safety of fund
⚫ To get capital appreciation
⚫ To maintain liquidity
⚫ Longer life expectancy or planning for retirement
⚫ High interest rates
⚫ Availability of a complex number of investment outlets.
 Investment Constraints

⚫ Liquidity Constraints - (need for cash in excess of new

contributions),
⚫ time horizon,
⚫ Tax concerns,
⚫ legal and regulatory factors
⚫ Unique circumstances (social responsibility considerations ,
health needs, support of dependents)
⚫ Market Conditions
The Investment Process
 Investment Policy
⚫ Investment policy is the first stage of the investment
process. It determines the following aspects of the investor:
his initial step determines the investor’s objectives and the
amount of his investable wealth
This step concludes with the asset allocation decision:

⚫ Determination of Investable Wealth

⚫ Determination of Portfolio Objectives
⚫ Identification of Potential Investment Assets
⚫ Consideration of Attributes of Investment Assets
⚫ Allocation of Wealth to Asset Categories.
 Investment analysis –
Investment analysis is the second stage of the investment
process. Investor analysis of the investment is made on the
following grounds:
This step is the security selection decision: Within each asset type,
identified in the asset allocation decision, how does an investor select
which securities to purchase.
⚫ Investment analysis involves examining a number of individual
securities within the broad categories of financial assets identified in
the previous step.
⚫ One purpose of this exercise is to identify those securities that
currently appear to be mispriced. Security analysis is done either using
Fundamental or Technical analysis (both have been discussed in
subsequent units).
⚫ Fundamental analysis is a method used to evaluate the worth of a
security by studying the financial data of the issuer. It scrutinizes the
issuer’s income and expenses, assets and liabilities, management, and
position in its industry. In other words, it focuses on the ‘basics’ of the
business.
⚫ Technical analysis is a method used to evaluate the worth of a security
by studying market statistics. Unlike fundamental analysis, technical
analysis disregards an issuer’s financial statements. Instead, it relies
upon market trends to ascertain investor sentiment to predict how a
security will perform.
Continue…….

⚫ Equity Stock Analysis

⚫ Screening of Industries
⚫ Analysis of the Economy
⚫ Consideration of Debentures
⚫ Quantitative Analysis of Debentures
⚫ Other Asset Analysis
1. Qualitative Analysis
2. Quantitative Analysis
 Valuation of Securities
Valuation of the securities is the third stages of the
investment
process. This stage involves
⚫ Valuation of Stocks
⚫ Valuation of Debentures and Bonds
⚫ Valuation of Other Assets
 Portfolio Construction
Portfolio construction involves the following areas as
outlined below that:
⚫ Determination of Diversification Level
⚫ Consideration of Investment Timing
⚫ Selection of Investment Assets
⚫ Allocation of Investable Wealth to Investment Assets
⚫ Evaluation and revise the Portfolio for Feedback
 Evaluate the performance of Portfolio

⚫ This step involves determining periodically how the

portfolio has performed over some time period (returns
earned vs. risks incurred).
⚫ Continuous evaluation of the portfolio should be done
so that objective of investment can be achieved and
essential actions and measures can be taken.
 Follow up/Revise the Portfolio

⚫ On the basis of evaluation and market conditions portfolio

should be revised.
⚫ This step is the repetition of the three previous steps, as
objectives might change and previously held portfolio
might not be the optimal one
Risk
⚫ Uncertainty in the expected outcome
⚫ A state of uncertainty where some possible outcomes
have an undesired effect or significant loss.
⚫ Risk is the potential of gaining or losing something of
value.
⚫ Risk can also be defined as the intentional interaction
with Uncertainty . Uncertainty is a potential,
unpredictable, and uncontrollable outcome; risk is a
consequence of action taken in spite of uncertainty.
Types of risk
⚫ Unsystematic –
Unsystematic risk is controllable by an organization and
micro in nature.

⚫ Systematic-
Systematic risk is uncontrollable by an organization and
macro in nature.
Unsystematic Risk

⚫ Unsystematic risk is due to the influence of internal

factors prevailing within an organization. Such factors
are normally controllable from an organization's point
of view.
⚫ It is a micro in nature as it affects only a particular
organization. It can be planned, so that necessary
actions can be taken by the organization to mitigate
(reduce the effect of) the risk.
Unsystematic Risk
⚫ Management Risk
⚫ Business risk
⚫ liquidity risk,
⚫ Financial risk
⚫ credit / default risk
⚫ Operational risk.
Systematic Risk

⚫ Systematic risk is due to the influence of external

factors on an organization. Such factors are normally
uncontrollable from an organization's point of view.
⚫ It is a macro in nature as it affects a large number of
organizations operating under a similar stream or same
domain. It cannot be planned by the organization.
The Types of systematic risk
⚫ Interest rate risk
-Price risk
-Reinvestment risk
⚫ Market risk
⚫ Purchasing power risk / Inflationary risk
-Demand Inflation risk
-cost inflation risk
⚫ Foreign Exchange Risk
-Transaction
-Translation
⚫ Country risk
Conti…
⚫ Economic risk
⚫ Sovereign risk
⚫ Political risk
⚫ legal risk
Risk Management
In the financial world,
Risk management is the process of identification, analysis and
acceptance or mitigation of uncertainty in investment decisions.
“

Essentially, risk management occurs any time an investor or fund

manager analyzes and attempts to quantify the potential for
losses in an investment and then takes the appropriate action (or
inaction) given his investment objectives and risk tolerance.
Principles of risk management
⚫ Identification (Know/ Understanding) the risk
⚫ Risk tolerance
⚫ Rules are important
⚫ Goals/objectives should be realistic
⚫ Flexibility
⚫ Know your financial limitations
⚫ It’s never too early to start investing
Role of security market in Indian economy
⚫ Mobilizing Savings
⚫ Promoting Investments
⚫ Encouraging Investments in Financial Assets
⚫ Creating Credits
⚫ Allocating Savings on the basis of National priorities
⚫ Providing a Spectrum of Financial Assets
⚫ Financing trade, industry and Agriculture
⚫ Encouraging Entrepreneurial talents
⚫ Providing Financial Services
⚫ Developing Backward Areas
 Current Scenario of Investments
⚫ In India, increase in working population, larger family
income and consequent higher savings
⚫ Provision of tax incentives in respect of investments in
specified channels provided by government
⚫ Intensive competition
⚫ Increasing tendency of people to hedge against
inflation that protected by government
⚫ Increase in number of players in the financial system
⚫ Availability of large and attractive investment
alternatives developed in India
⚫ Increase in investment related publicity in India
⚫ Ability to invest to get income and capital gains etc.
⚫ More Customization
Investment avenues
⚫ Equity shares
⚫ Preference shares
⚫ Debt instruments (bonds/debentures)
⚫ Mutual Funds
⚫ Insurance(life insurance/general insurance)
⚫ Bank deposits(ex-FD,RD)
⚫ Commodities(ex-gold)
⚫ PPF /EPF
⚫ Derivatives
⚫ Real estate
⚫ Pension funds