Introduction to Investment and Securities

To To To

understand the concept of investment

explain process of investment learn about various types of securities

To

analyze various sources of investment information

Savings is the portion of current income not spent on consumption.

Investments
Investing is the purchase of assets with the goal of increasing future income.

 Risk

The chance that the value of an investment will decrease.

The profit or yield from an investment. The ability of an investment to be converted into cash quickly without loss of value.

Return

Liquidity

 Savings
Low

Investments
High

risk Low return High liquidity

risk High return Low liquidity

Today, a large soft drink at your favorite fast-food place costs 10.00. You buy the soft drink but also decide to save some money for the future as well. So you put 10 Rupee in your savings account, where it earns 10%.
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One year later, the Rupee in your saving account is worth 11. You take the money out and visit your favorite convenience store, hoping to buy another delicious beverage. Unfortunately, drinks now cost 12.
NEFE

The point? Inflation can work against your money. You need to learn to invest wisely, follow the rate of inflation, and make sure your investment rates are higher than those of inflation.

 The

time value of money refers to the fact that a dollar in hand today is worth more than a dollar promised at some future time.

 Refers

to the amount of money to which an investment will grow over a finite period of time at a given interest rate. Put another way, future value is the cash value of an investment at a particular time in the future.

 Respond

to this statement on your guided notes and then discuss it with a partner. How does it relate to future value?

Picture from NEFE

 What

is the relationship between risk and return?

 Saving

for a senior trip Saving for a down payment on a house Saving for retirement

Sample Student Work

Sample Student Work

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.

 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 profit from the price fluctuations. An individual who undertakes the activity of speculation is known as 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

 Return

Income: The total income, the investor receives during his holding period.
End period value Purchase period value + Dividends Return = 100 Purchase period value

Risk:

Variability in the return. Liquidity: The ease with which the investment is converted into cash. Safety: It refers to the legal and regulatory protection to the investment. Hedge against inflation: The returns should be higher than the rate of inflation.

Securities

They are instruments which represent a claim over an asset or any future cash flows. Securities are classified on the basis of return and source of issue.
Fixed income securities

Return Variable income securities Issuers

Government Quasi-Government Public Sector Enterprises Corporates

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 Analyses: Economic, industry and company analyses 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. Portfolio Construction: Portfolio is diversified to maximise return and minimise risk. Portfolio Evaluation: The performance of the portfolio is appraised and revised.

There are different types of preference stocks, which are:

Cumulative preference shares

Non-cumulative preference shares Convertible preference shares Redeemable preference shares Irredeemable preference shares Cumulative convertible preference shares

Common stock or ordinary shares are most commonly known as equity shares. Stock is a set of shares put together in a bundle. A share is a portion of the share capital of a company divided into small units of equal value. The advantages of equity shares are:

Capital appreciation Limited liability Hedge against inflation

 It

is a new equity instrument introduced in the Companies (Amendment) Ordinance, 1998. It forms a part of the equity share capital as its provisions, limitations and restrictions are same as that of equity shares.
Sweat Equity is for:
The

directors or employees involved in the process of designing strategic alliances. The directors or employees who have helped the company to achieve a significant market share.

 The

shares that carry no voting rights are known as non-voting shares. They provide additional dividends in the place of voting rights. They can be listed and traded on the stock exchanges.

 Distribution

of shares, in addition to the cash dividends, to the existing shareholders are known as bonus shares. These are issued without any payment for cash. These are issued by cashing on the reserves of the company. A company builds up its reserves by retaining part of its profit over the years.

 Preference

stock provides fixed rate of

return. Preference stockholders do not have any voting rights. Like the equity, it is a perpetual liability of the corporate. Preference stockholders do not have any share in case the company has surplus profits.

It is a debt instrument issued by a company, which carries a fixed rate of interest. It is generally issued by private sector companies in order to acquire loan. The various features of a debenture are:

Interest

Redemption

Indenture

A company can issue various types of debentures, which are:

Secured bonds or unsecured debenture Fully convertible debenture Partly convertible debenture Non-convertible debenture

A bond is a debt security issued by the government, quasi- government, public sector enterprises and financial institutions. Various features of a bond are:

The interest rate is generally fixed It is traded in the securities market At the time of issue of bonds, maturity date is specified

Some of the types of bonds that a company can issue are:

Secured bonds and unsecured bonds Perpetual bonds and redeemable bonds Fixed interest rate bonds and floating interest rate bonds Zero coupon bonds

A warrant is a detachable instrument, which gives the right to purchase or sell equity shares at a specified price and period. It is traded in the securities market where the investor can sell it separately. Two types of warrants are:
Detachable warrants: When the warrants are issued along with host securities and detachable, then they are known as detachable warrants. Puttable warrants: Represent a certain amount of equity shares that can be sold back to the issuer at a specified price, before a stated date.

Some of the advantages of warrants are:

They have limited risk. They offer potential for unlimited profits. They can be traded in the securities market.

 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

By now, you should have: Understood the concept of investment and speculation Learnt about the various types of shares and debentures Understood the various sources of investment information

Chapter 2

Investment Alternatives

 To

understand the concept of investment alternatives To distinguish between negotiable and non-negotiable securities To know the various types of real assets

 Investment

alternatives mean investment in assets other than the shares or debentures of a company. The alternatives range from financial securities to traditional non-security investments. The financial securities may be negotiable or non-negotiable securities.

The financial securities that are transferable are known as negotiable securities. Negotiable securities can be of two types:
Variable

income securities Fixed income securities

Equity shares comes under the category of variable income securities Debentures, Bonds, Kisan Vikas Patras, Indira Vikas Patras and Government securities all come under the category of fixed income securities.

Fixed income securities are the financial claims with promised cash flows of fixed amounts, paid at fixed dates. Fixed income securities are classified as:

Preference shares: Refer to the shares that provide a fixed rate of dividend to the preference shareholders. Debentures: Refer to a long term debt instrument issued by corporate entities to acquire finance. Bonds: Refer to a debt security issued by the government, quasi-government, public enterprises and financial institutions. Government securities: Refer to the securities that are issued by the Central, State and quasi-government agencies. Money market securities: Refer to the securities that have a very short term maturity period.

 The

financial securities that are not transferable are known as non-negotiable securities. They are also known as non-securitized financial investments. The deposit schemes that are offered by the post offices, companies, banks, etc. form a part of the non-negotiable securities. Deposit facility is offered by banks and post offices.

The various types of tax sheltered savings schemes are:

Public

Provident Fund Scheme: It provides yearly interest which is exempted from income tax under Section 88. Savings Scheme: It provides 100 per cent tax rebate to the depositors.

National

National

Savings Certificate: It is a scheme provided by the post offices for a period of six years. Once money is deposited, no withdrawals are permitted, but loans can be taken.

 It

is an agreement made between the insurance company and the insured person. The insurance company has to pay a certain amount of money on the occurrence of the event insured against. The advantages of life insurance are:

Protection Liquidity Easy payments Tax relief on specified schemes

 These

are professionally managed portfolios of securities. They can be classified into two forms:
Open-ended

schemes: These offer their unit on a continuous basis. Repurchase is also carried out on a continuous basis. It is not traded in the stock exchange. Close ended schemes: These are schemes in which the number of units are fixed and are traded in the stock exchange.
The

factors to be considered in the selection of mutual funds are:

Net assets

Income composition

Real assets are tangible assets, which include:

Gold and silver

Real estate Art Antique items

By now, you should have: Understood the concept of investment alternatives Learnt to distinguish between negotiable and non-negotiable securities Knowledge of the various types of real assets