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Introduction to Investments

Outline

Introduction (Real v/s Financial asset) Investment Features and Objectives Sources of Investment Information Why do individuals invest? Why Study Investments? Features and objectives Types of investors

Real assets and Financial asset

Real assets Physical assets (land, building, machinery, knowledge) Financial assets Paper assets (stocks, bonds, derivatives, currencies)

Meaning of Investments

Commitment of money that is expected to generate additional money Current commitment of funds for a period of time to desire future payments that will compensate the investor for

The time the funds are committed The expected rate of inflation, and The uncertainty of the future payments

Investment

Investment is the employment of funds on assets to earn income or capital appreciation.

The individual who makes an investment is known as the investor. In economic terms, investment is defined as the net addition made to the capital stock of the country.

In financial terms, investment is defined as allocating money to assets with a view to gain profit over a period of time.

Investments in economic and financial terms are inter-related where an individual's savings flow into the capital market as financial investment, which are further used as economic investment.

Why do individuals invest?

To achieve a higher level of consumption in the future by forgoing consumption today

To improve our welfare in the future

Investments help us achieve tradeoff between current


consumption and future consumption

Basic element of all investment decisions: trade-off between expected return and risk

Why Study Investments?

The Personal Aspects

Knowledge of investments help investors understand the relationship between risk and return Manage their own wealth
To become a licensed broker, CFA/CFP, Security Analyst, Portfolio Manager.

Investment as a Profession

Features of Investment :

Return Risk Liquidity / Marketability Tax shelter Convenience

Objectives of Investment :

Safety Regularity of income Capital Appreciation Minimization of Risk Liquidity Hedge against Inflation Tax Considerations Arbitrage

Types of Investors

Individuals Institutions Insurance Companies Mutual Funds Banks FII

Investment Constraints :

Time Investors Age Risk Tolerability Liquidity / Marketability Need for Regular Income Tax Liability / Exemption

Errors while Investing


Inadequate comprehension of return and risk. Vaguely formulated investment policy. Naive extrapolation of the past. Cursory decision-making. Simultaneous Switching Misplaced love for cheap stocks. Over diversification and under-diversification. Buying shares of familiar companies Wrong attitude toward losses and profits. Tendency to speculate.

Speculation

Speculation means taking business risks with the anticipation of acquiring short term gain. It also involves the practice of buying and selling activities in order to make profit from the price fluctuations. An individual who undertakes the activity of speculation is known as speculator.

Difference between Investor and Speculator


Base Investor Speculator Has a very short planning horizon. His holding period may be few days to months. His risk is high. Attaches greater significance to market behaviour and inside information. Uses borrowed funds along with his personal funds. Time horizon Has a relatively longer planning horizon. His holding period is usually of one or more than one year. Risk return Decision His risk is less. Attaches greater significance to fundamental factors and carefully evaluates the performance of the company. Uses his own funds.

Funds

The Investment Process


The process of investment includes five stages:
1.

2.

3.

4.

5.

Investment Policy: The policy is formulated on the basis of investible funds, objectives and knowledge about investment sources. Security Analysis: Economic, industry and company analysis are carried out for the purchase of securities. Valuation: Intrinsic value of the share is measured through book value of the share and P/E ratio. Future value of securities can be estimated using trend analysis Portfolio Construction: Portfolio is diversified to maximise return and minimise risk. Several modes are available: Debt and equity; industry diversification; company diversification. Portfolio Evaluation: The performance of the portfolio is appraised and revised.

Investment Information

An investor must have adequate knowledge about the investment alternatives and markets before making any kind of investment. The various sources from which an investor can gather the investment information are:

Newspapers, Investment dailies Magazines and Journals Industry Reports RBI Bulletin Websites of the SEBI, RBI and other private agencies Stock market information

FINANCIAL MARKETS A financial market is a market for creation and exchange of financial assets. Financial markets play a very pivotal role in allocating resources in the economy by performing three important functions as they : Facilitate price discovery. Provide liquidity. Reduce the cost of transacting.

FUNCTIONS OF FINANCIAL MARKETS


Facilitate Price Discovery The continual interaction among numerous buyers and sellers who participate in financial markets helps in establishing the prices of financial assets Provide Liquidity Thanks to the liquidity provided by financial markets, it is possible for companies (and other entities) to raise long-term funds from investors with short-term horizons Reduce the Costs of Transacting

Financial markets considerably reduce the following costs of transacting Search cost Information cost

CLASSIFICATION OF FINANCIAL MARKETS


DEBT MARKET NATURE OF CLAIM EQUITY MARKET MONEY MARKET MATURITY OF CLAIM CAPITAL MARKET PRIMARY MARKET SEASONING OF CLAIM SECONDARY MARKET CASH OR SPOT MARKET TIMING OF DELIVERY FORWARD OR FUTURES EXCHANGE-TRADED MARKET ORGANISATIONAL STRUCTURE OVER-THE-COUNTER MARKET

FINANCIAL MARKET RETURNS


Interest Rate Function of the unit of account, maturity, and default risk Rate of Return on Risky Assets Cash dividend r= Beginning price Dividend yield Inflation and Real Interest Rate 1 + Nominal rate 1 + Real rate = 1 + Inflation rate

Ending price Beginning price Beginning price Capital yield

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