A) Investment Definition
An investment
is any vehicle into which funds can be placed with the expectation of preserving or
increasing value and earning a positive rate of return. An investment can be a security or a
property. Individuals invest because an investment has the potential to preserve or increase
value and to earn income. It is important to stress that this does not imply that an investment will
in fact preserve value or earn income. Bad investments do exist.
B) Types of Investments
1. Securities or Property
2. Direct or Indirect
3. Debt, Equity, or Derivative Securities
4. Low or High Risk
5. Short or Long Term
6. Domestic or Foreign
Securities and property are simply two classes of investments.
Securities are investments, commonly evidenced by certificates, that represent a legal claim.
For example, a bond represents a legal claim on debt, and a stock represents a proportionate
ownership in the firm. An option, on the other hand, represents the legal right to either buy or sell
an asset at a predetermined price within a specified time period.
Property constitutes investments in either real property (land and buildings) or tangible
personal property (Rembrandt paintings, Ming vases, or antique cars).
With a direct investment, an individual acquires a direct claim on a security or property. For
example, an investment in one share of IBM stock directly provides the stockholder a
proportionate ownership in IBM.
An indirect investment provides an indirect claim on a security or property. For example, if
you bought one share of Fidelity Growth Fund (a mutual fund), you are in effect buying a portion
of a portfolio of securities owned by the fund. Thus, you will have a claim on a fraction of an
entire portfolio of securities.
An investment in debt represents funds loaned in exchange for the receipt of interest income
and repayment of the loan at a given future date. The bond, a common debt instrument, pays
specified interest over a specified time period, then repays the face value of the loan
An equity investment provides an investor an ongoing fractional ownership interest in a firm.
The most common example is an investment in a company’s common stock.
Derivative securities are securities derived from debt or equity securities and structured to
exhibit characteristics different from the underlying securities. Options are derivative securities
that allow an investor to sell or buy another security or asset at a specific price over a given time
period. For example, an investor might purchase an option to buy Company X stock for $50
within nine months.
In finance, risk refers to the chance that the return from an investment will differ from its
expected value. The broader the range of possible values (dispersion), the greater the risk of the
investment.
Low-risk investments are those considered safe with respect to the return of funds invested
and the receipt of a positive rate of return. High-risk investments are those which have more
uncertain future values and levels of earnings.
Short-term investments typically mature within one year while long-term investments have
longer maturities, like common stock, which has no maturity at all. However, long-term
investments can be used to satisfy short-term financial goals.
Foreign investments are investments in the debt, equity, derivative securities of foreign based
companies and property in a foreign country. Both direct and indirect foreign investments
provide investors more attractive returns or lower-risk investments compared to purely domestic
investments. They are useful instruments to diversify a pure domestic portfolio.
C) The Structure of the Investment Process
The investment process brings together suppliers and demanders of funds. This may occur
directly (as with property investments). Most often the investment process is aided by a financial
institution (such as a bank, savings and loan, savings bank, credit union, insurance company, or
pension fund) that channels funds to investments and/or a financial market (either the money
market or the capital market) where transactions occur between suppliers and demanders of
funds.
(a) The various levels of government (federal, state, and local) require more funds for
projects and debt repayment than they receive in revenues. Thus, governments are net
demanders of funds. Governments also demand funds when the timing of their revenues do not
match their expenditure. The term net refers to the fact that, while governments both supply and
demand funds in the investment process, on balance they demand more than they supply.
(b) Businesses also are net demanders, requiring funds to cover short- and long-term
operating needs. While business firms often supply funds, on balance they also demand more
than they supply.
(c) Individuals are the net suppliers of funds to the investment process. They put more
funds into the investment process than they take out. Individuals play an important role in the
investment process—supplying the funds needed to finance economic growth and development.
D) Types of Investors
Institutional investors are investment professionals who are paid to manage other people’s
money. They are employed by financial institutions like banks and insurance companies, by non-
financial businesses, and by individuals.
Individual investors manage their own personal funds in order to meet their financial goals.
Generally, institutional investors tend to be more sophisticated because they handle much larger
amounts of money and they tend to have a broader knowledge of the investment process and
available investment techniques and vehicles.
