Part I : The Investment Environment

C1
Nature and Scope of Investment Decisions

Chapter 1

Nature and Scope of Investment Decisions

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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Definition of Investment

Investment involves making of a sacrifice in the

present with the hope of deriving future benefits. Investment has many meanings and facets. The two most important features of an investment are current sacrifice and future benefit.

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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Why Invest?
We invest in order to improve our future welfare.

Funds to be invested come from assets already owned,

borrowed money, and savings or foregone consumption. By foregoing consumption today and investing the savings, we

expect to enhance our future consumption possibilities.

Anticipated future consumption may be by other family members, such as education funds for children or by ourselves,

possibly in retirement when we are less able to work and

produce for our daily needs.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Nature of Investment Decisions

Investment decisions are premised on an important assumption that investors are rational and hence prefer certainty. They are risk averse which implies that they would be unwilling to take risk just for the sake of risk. Investors are more often concerned with RISK and RETURN. The basic investment decision would be a trade-off between risk and return.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

The Investment Process A typical investment decision undergoes a five step procedure which, in turn, forms the basis of the investment process. These steps are: 1. Determine the investment objectives and policy.

2. Undertake security analysis.

3. Construct a portfolio. 4. Review the portfolio. 5. Evaluate the performance of the portfolio.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

1. INVESTMENT OBJECTIVES AND POLICY:

The investor will have to work out his objectives first and then
evolve a policy with the amount of investible wealth on his hand. Hence, the objectives of an investor must be defined in terms of

risk and return.

The next step in formulating the investment policy of an investor would be the identification of categories of financial assets

he/she would be interested in.

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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

2. SECURITY ANALYSIS:
This step would consist of examining the risk-return characteristics of individual securities or groups of securities identified under step one. The aim here is to know if it is worthwhile to acquire these securities for the portfolio. And there are two broad approaches to finding out the mispriced status of individual securities. One approach is known as technical analysis. The second approach is known as fundamental approach.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

3. PORTFOLIO CONSTRUCTION:
This consists of identifying the specific securities in which to invest and determining the proportion of the investors wealth to be invested in each. Portfolio construction address itself to three major problems via., selectivity, timing, and diversification.
The related questions would be: which specific shares/debentures to buy, when to buy, and how best to combine them in such a way which minimize the overall risk for a given level of expected return. Cont.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

4. PORTFOLIO REVISION:
As time passes, the investor would discover that securities that once were very attractive have ceased to be so. Also, new securities with promises of high returns and relatively low risk have emerged. In view of such developments it would be necessary for him to review the portfolio. He would liquidate the unattractive securities and acquire the new one from the market. In a way, he repeats the first three steps of the investment process.

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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

5. PORTFOLIO PERFORMANCE EVALUATION:

A rational investor would constantly examine his chosen portfolio both for average return and risk. Measures, for doing so, must be developed.
Also, the calculated risk-return positions must be compared with certain yardsticks or norms. This step in the investment process, thus, acquires considerable significance since the tasks involved are quantitative measurement of actual risk and return their evaluation against objective norms.
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Part I : The Investment Environment

C1 Nature and Scope of Investment Decisions The Investment Environment
Investment decisions to buy/sell securities taken by individuals and institutions are carried through a set of rules and regulations. There are markets money and capital which function subject to such rules and established procedures and are, in turn, regulated by legally constituted authority.

Then there are securities or financial instruments, which are the objects of purchase and sale. Finally, the mechanism which transfers from one owner to another comprises of a host of intermediaries. All these elements comprise the investment environment. Investors have to be fully aware of this environment for making optimal investment decisions.
The three elements of the investment environment viz., instruments, institutions and markets are of PRIME IMPORTANCE.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Financial Intermediaries
Financial intermediaries perform the intermediation function i.e., they bring the users of funds and the suppliers of funds together.
Many of them issue financial assets.

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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Investment versus speculation

Basis of Difference
Planning Horizon Holding Period

Investment

Speculation

An Investor has a relatively A Speculator has very longer planning horizon short planning horizon. Normally 1 year or more Few days to few months Daring and careless

Psychological attitude Cautious and conservative of participants

Return Expectations
Quantity of risk Stability of income

Moderate
Small Very stable

Very High
Large Uncertain and variable

Basis of decisions

Fundamental Analysis and Technical Analysis and careful evaluation of Market Psychology prospects of firm.
Earnings of enterprise
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Source of income
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Investment versus Gambling speculation

Speculation typically lasts longer than gambles but are briefer than investments. A speculation usually involves the purchase of a salable asset in hopes of making a quick profit from an increase in the price of the asset which is expected to occur within a few weeks or months. Those involved in speculations are reluctant to refer to this activity as speculation because they dislike the connotations of the word; they prefer to refer to speculations as investment activities.
A gamble is usually a very short-term investment in a game of chance. The holding period for most gambles can be measured in seconds.

That is, the result of so-called investments is quickly resolved by the roll of the dice or the turn of a card.
Such activities have planning horizons that are far too brief to do the research that should precede any investment activity.

Rational people gamble for FUN and not for an INCOME.

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Cont.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

GAMBLING V/S SPECULATION: Speculation is not the same as gambling and the two should never be confused. The difference between speculation and gambling is that in gambling, artificial and unnecessary risks are created whereas in speculation the risks already exist and the question is simple who shall bear them? Gambling is a far cry from the carefully planned research and scientific procedure which underlies the best speculative practice. The gambler plays rumors, tips, guesses and other unreliable intuitions which should not play any but a negative role in the trained speculators process. Speculation is a reasoned anticipation of future conditions. It does not rely upon gossip or labels. It attempts to organise the relevant knowledge as a support for judgments. It is as legitimate and moral as any other form of risk-taking business activity.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Investment Attributes/Factors influencing selection of investment

For evaluation of investment avenue, the following attributes are relevant: 1. Returns 2. Capital Appreciation Conservation

Aggressive growth Speculation

Periodic cash receipts Capital gain

Form of return

3. Safety and security of funds Risk Liquidity Tax considerations Conceal ability
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Part I : The Investment Environment

C1 Nature and Scope of Investment Decisions Investment Alternatives
Equity Preference shares Debentures Bonds or fixed income securities Government securities Savings bonds Private sector debentures PSU bonds Preference shares Money market instruments Treasury bills Certificates of deposits Commercial paper Repos
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Cont.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Non-marketable financial assets

Bank deposits
Post office time deposits (POTD) Monthly income scheme of the post office (MISPO) Kisan Vikas Patra (KVP)

National savings certificate

Company deposits Employees provident fund scheme Public provident fund scheme

Cont.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Real estate

Residential House
Sources of Housing Finance Features of Housing Loans Guidelines for Buying a Flat Commercial Property Agricultural Land Suburban Land Time Share in a Holiday Resort

Cont.
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Precious objects Gold and Silver Precious Stones Art Objects Insurance policies

Endowment Assurance
Money Back Plan Whole Life Assurance Unit Linked Plan Term Assurance Annuity Plans
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Investments and Innovation

Technology Advancements in computing power and Internet technology More complete and timely information delivery Globalization Domestic firms compete in global markets Broad variety of Financial Instruments Leads to diversification of risk Globalization continues and offers more opportunities Securitization continues to develop Derivatives continue to develop Strong economic growth Integration of investments and corporate finance
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Part I : The Investment Environment

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Nature and Scope of Investment Decisions

Types of Investor

Measured Investor

Reluctant Investor

Competitive Investor
Unprepared Investor

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C1
Chapter Ends

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