INTRODUCTION TO INVESTMENTS

INVESTMENT
• In accounting, Investment refers to assets held by the
business for the accretion of wealth through distribution.

• In economics, Investment refers to tangible or physical assets

like buildings, pieces of machineries, or equipment that
contribute income to the business or individual.

• In finance, Investment is the amount of money invested in

financial assets like bonds, stocks, mutual funds, or insurance
policies.
Investment provides
financial or economic
returns to the
business.
 2 Classification of Investments

1. Financial Instruments

2. Non-financial instruments
 Financial Instrument
• Is a contract that provides financial assets to one party and, at the same
time, entails financial liability or equity to another.
• Investments classified as financial instruments are:
1. stocks or equity instruments
2. bonds or debt instruments
3. cash and cash equivalents
4. trade accounts
5. mutual funds
6. insurance funds
Cash – includes bills, coins, and money deposited in the bank.

Cash equivalents – includes short-term and highly liquid investments that are readily
convertible to cash. Ex. Treasury bills of the BSP, time deposits, or
money market instrument.

Trade accounts – represent the right to collect a sum of money in the near future.

Mutual Funds – refer to money pooled together by people and kept and handled by a
professional manager.

Insurance fund – refers to money collected and pooled by insurance companies from
the premiums paid by the insured or policyholders and used as
protection or hedge against uncertain risks.
 Non-Financial Instruments
Real properties – are non-financial instruments that represent hard or fixed
assets usually attached to the soil.

Inventories – are products that are intended for sale but remain unsold at the
end of the period.

Patents – are intangible non-financial instruments granted by the government.

Gold Bullion – is a precious commodity which carries a high market value most
especially when the market is volatile.
 Investment in Bonds
• A bond is an unconditional promise to pay:
a. a specified sum of money at a determinable future time; and
b. its periodic interest is based on the agreement.
• Bonds can be classified as follows:
1. term bonds- have single maturity date.
2. serial bonds- have series of maturity dates.
3. callable bonds- are bonds that can be called in or redeemed by the
issuing company prior to the date of maturity.
4. convertible bonds – that offer the bondholder the right to convert or
exchange the bonds prior to their maturity date with
shares of stock.
 Nominal Rate and Effective Interest
Nominal Rate – refers to the interest rate that appears on the face of the bonds.
Effective interest rate – otherwise known as yield to maturity or market rate of interest.
- the true or actual rate of interest that investors earn
from investment in bonds.
3 Factors influence the effective interest rates of the bonds:
a. real rate of return
b. inflation premium
c. risk premium
Business risk – is directly related to the inability of the business to maintain stability
and growth in its earnings as a result of losing its competitive position in
the market.
Financial risk – is directly related to the liquidity problem of the business, that is, not
being able to settle its obligations as they mature.
 Valuation of Bonds
Valuation - refers to the value of the bonds at the time of investment.
- It is the amount that the investor is willing to pay the issuing
company.
• The value of the bonds is equal to the market price at the time of
investment.
• The market price of the bond is equal to the sum of the following :
a. present value of cash flows of the principal on maturity date
b. present value of all future cash flows from interest
• The difference between the market price and the face value of the bonds
is called discount on bonds.
 Investment in Stocks
• Owning a share of stock makes the buyer an owner of a corporation.
• The buyer is also called a stockholder or a shareholder.
• Putting money in bonds are buying debt instruments while buying shares
of stocks are buying equity instruments.
• Bondholders earn income in the form of interest while stockholders earn
through dividends.
• Two types of Shares of stocks:
1. common stock or ordinary shares
2. preferred stock or preference shares
 Valuation of Stocks
 The value of the stocks is based on the par value.
 Par value refers to the nominal value of the shares of stocks appearing on the
face of the stock certificate.
 No-par value stock refers to shares that do not have par value.
 The Corporation Code of the Philippines prohibits any corporation from
issuing shares of stock below the par value.
 The sale of stocks based on their stock price happens when the corporation
goes into public for the first time.
 The stock price or current market price is considered the “true” or intrinsic
value of the stocks.
 Two stock valuation methods
1. Discounted dividend model

2. Constant growth model

 Discounted dividend model
• Valuation of stock is based on the present value of cash flows arising from the
following elements:
a. cash dividend every year
b. price of the stock when sold
• Formula to compute the stock price using the model:
𝑑𝑝𝑠
𝑆=
𝑟 −𝑔

Where: S – stock price of the common stocks

dps – dividend per share
r – required rate or discount rate on stock
g – dividend growth rate
 Constant Growth Stock Valuation Model
• Appraises the stock on the assumption that future dividends of companies will
grow at a constant rate.
• This model may be applied to companies that have been in the market for
several years since they may already have a growth pattern on dividend
distribution.
• Formula to compute the value of stock using this model:
𝐷0 (1 +𝑔) 𝐷
𝑆= or 1
𝑟 −𝑔 𝑟 −𝑔
Where: S – Stock price of the common stocks
𝐷0 - Current dividend
𝐷1 - Next year dividend at time 1
r – Required rate of return
g – Growth rate of dividend
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