What is an Investment
An investment is the current commitment of money and other resources in the expectation of reaping future benefits. For example, an individual might purchase shares of stock anticipating that the future proceeds from the shares would be high enough to justify the time that the money is tied up as well as the risk of the investment. In short, making an investment is to sacrifice something of value now, expecting to benefit from that sacrifice later.
Section :2
Real vs. Financial Assets
At the broadest level, investments can be classified into two categories:
I) Investments in Real Assets
Real assets are tangible assets that determine the productive capacity of an economy, that is, the goods and services its members can create. These include land, buildings, machines, and knowledge that can be used to produce goods and services. Other common examples of investments in Real Assets are paintings, antiques, precious metals and stones, classic cars etc.
II) Investments in Financial Assets
Financial Assets, or more commonly known as Securities, include stocks, bonds, unit trusts etc. In essence, financial assets or securities represent legal claim on future financial benefits. These are no more than sheets of paper and do not contribute directly to the productive capacity of the economy. Instead, these financial assets are the means by which individuals hold their claims on real assets and the income generated by these real assets.
While both real and financial assets represent important avenues for investments, in this Tutorial investments in financial assets or securities would primarily be focused on. However, most of the concepts and tools discussed here can also be used for analyzing investments in real assets.
Section :3
Financial Markets
Financial Markets are categorized into: 1- Money Market 2- Capital Market 3- Securities Market. Here we will discuss Securities Market, which can be divided into markets for Marketable and Non-Marketable Securities.
Section :4
Money Market Securities
Money market securities sometimes are called cash equivalents, or just cash for short. The money market is a sub-sector of the fixed-income market. It consists of very short-term debt securities that are highly marketable. Many of these securities trade in large denominations and are out of the reach of individual investors. Money Market Mutual Funds, however, are easily accessible to small investors. These mutual funds pool the resources of many investors and purchase a wide variety of money market securities on their behalf. Most commonly traded money-market instruments include:
An important measure that differentiates money market securities from capital market securities is the time to maturity. Money market securities, essentially, have maturity period of one year or less.
|
| Complete | No. | Name |
|---|---|---|
| 1 | Fixed-Income Capital Market | |
| 2 | Equity Market | |
| 3 | Derivatives Market |
Capital markets, in contrast, include longer term and riskier securities. Their maturity is typically more than one year or, in some cases, indefinite. Securities in the capital market are much more diverse than those found within the money market. Examples include stocks, long-term bonds etc. Capital Market can be further divided into three sub-categories:
I) Fixed-Income Capital Market
II) Equity Market
III) Derivatives Market
Section :6
Financial Markets & Instruments at a Glance
The following diagram outlines the various categories of financial markets and instruments:
Section :7
The Investment Process
An investor’s portfolio is simply a collection of investment assets. For example, an investor’s portfolio might comprise of a collection of stocks, bonds, mutual fund shares, commodities and some real estate. Once the portfolio is established, it is updated or “re-balanced” by selling existing securities and using the proceeds to buy new securities, or by selling/buying securities to decrease/increase the size of the portfolio. As mentioned, investment assets can be categorized into broad asset classes, such as stocks, bonds, real estate, commodities, and so on. The investment process can broadly be divided into the following three steps:
Asset Allocation: Allocation of an investment portfolio across broad asset classes such as stocks, bonds shares of mutual funds, real estate, etc.
Security Selection: Choice of specific securities within each asset class.
Trade Execution: Actual purchase (or sale at some later stage) of the security through a broker or dealer.
The steps will be discussed in greater detail in later chapters.
Section :8
The Risk-Return Trade-Off
Investors invest for anticipated future returns that can not be predicted precisely. There will almost always be risk associated with investments and actual or realized return will almost always deviate from the expected return anticipated at the start of the investment period. If two securities with similar returns have varying degree of risk, all investors will obviously go for the low risk security and the high demand would increase the price of security, thus decreasing the expected return. Hence, based on market demand dynamics, the security with low risk will offer a lower return while the security with higher risk will offer higher return. This is the fundamental truth in financial markets: securities with high risk will have to offer a high expected return to be attractive for investment while securities with low risk will still have demand even if they offer a lower return. Hence we see that government bonds have a very low expected return while the expected return of stocks (which are supposed to be more risky) is much higher in comparison. Therefore, the return is directly proportional to the risk and in order to earn higher return, investors will have to accept higher risk.
Section :9
Types of Investors
While there are many types of investors, they can broadly be classified into two categories:
I) Individual Investors: These include individuals who want to invest their savings into stocks, bonds, etc. Any one of us, who calls up a broker and places an order for a stock or bond, is an individual investor. In most cases, the portfolio of individual investors is not very large and comprises of only a few securities.
II) Institutional Investors: Institutional investors are organizations that pool investor funds for making investments and capitalize on their superior research and portfolio management capabilities. Examples of institutional investors include mutual funds, pension funds, insurance companies, endowment funds, commercial banks, etc. In addition to the accumulation of superior analytical and information resources, institutional investors also benefit from economies of scale.
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