Module 1.
Concept of Investment
Investment is conversion of cash into an asset or a security with the aim of achieving a return. It is
defined as an activity that commits funds in any financial/physical form in the present with an expectation
of receiving additional return in the future. Investment involves allocating resources, usually money, with
the expectation of generating an income or profit.
The core objective of investment management is to achieve a desired investment return within the
boundaries of an investor’s risk tolerance, time horizon, and financial goals. The process encompasses
asset allocation (determining the mix of types of investments,) asset selection (choosing specific measures
within each asset class), and portfolio strategy (balancing the risk against performance.).
Investment managers perform financial analysis, asset valuation, and monitor the financial market
environment to make informed decisions on buying, holding or selling assets. Investment is a cornerstone
of financial planning and economic development, serving as a bridge between present sacrifices and
future gains. Investment is the allocation of resources with the expectation of generating future returns.
This can involve financial investments like stocks and bonds, economic investments in physical assets
like machinery and infrastructure, or even investments in human capital through education and training.
Investment Management/Portfolio management/Wealth management
It is also known as portfolio management or wealth management, is the professional process of managing
various securities (stocks, bonds, etc.) and assets (like real estate)to meet specified investment goals for
the benefit of investors. Effective investment management aims at growing and preserving investor’s
assets, considering factors like market trends, economic conditions and individual client needs.
Definitions
Investopedia defines it as , “ An asset that is purchased with the hope that it will generate income or
appreciate in the future”.
Sharpe/Alexander defines “ Sacrificing of certain present value for some uncertain future value”.
Wikipedia defines investment as, “ Putting money into something with the expectation of gain, which
upon thorough analysis, has a high degree of security for the principal amount, as well as security of
return”.
Investment Attributes
1. Risk: The possibility of losing some or all of the invested capital. Different investments come with
varying levels of risk, from the relatively safe government bonds to the more volatile stocks.
2. Return: The gain or loss on an investment over a specified period. Return can come in the form of
dividends, interest payments, or capital gains and is often the primary focus for investors.
3. Liquidity: The ease with which an investment can be converted into cash without significantly
affecting its value. Highly liquid investments, like stocks of large companies, can be sold quicky, while
real estate is considered less liquid.
4. Volatility :The degree of variation in the price of an investment over time. High volatility means the
investment’s price can change dramatically in a short period, indicating higher risk and potentially higher
returns.
5.Diversification potential :The ability of an investment to help reduce risk in a portfolio by spreading
investments across various asset classes, sectors, or geographies.
6.Time Horizon : The expected duration an investment is held before taking profits or reallocating funds.
Some investments are better suited for short-term goals, while others are designed for long-term growth.
7. Tax efficiency : The impact of taxes on an investment’s returns. Some investments, like certain mutual
funds or retirement accounts, offer tax advantages to investors.
8. Costs and Fees ; The expenses associated with buying, holding, and selling an investment, including
brokerage fees, fund management fees, and transaction costs. These can significantly affect net returns.
9. Income Generation : The potential of an investment to produce income, such as interest or dividends,
which can be particularly important for investors seeking regular income streams.
10. Regulatory and legal environment : framework of laws and regulations that can affect the
performance and operation of an investment. Changes in regulations or legal challenges can impact
investment returns.
Economic Investment
Economic investment plays a important role in shaping the macroeconomic landscape, influencing
growth, productivity.
Economic investment refers to the expenditure on capital goods that are used to produce goods and
services in the future.
This includes spending on buildings, machinery, technology, and infrastructure, which contribute to an
economy’s productive capacity.
Importance of Economic Investment
It directly contributes to a country’s Gross Domestic Product (GDP), serving as one of the primary
components of GDP calculation.
Investment in capital goods increases the productive capacity of an economy, leading to higher output
levels and potentially enhancing the standard of living.
It drives technological advancement and innovation, as investments in research and development (R & D)
lead to new products, processes, and improvements in efficiency.
Types of Economic Investment
1. Business Investment: This is the most significant type of economic investment, encompassing
expenditures by businesses on capital goods. It includes investments in new factories, machinery, and
technology. Business undertake these investments to expand their production capacity, improve
efficiency, or enter new markets.
2. Residential Investment : This type involves spending on residential buildings and housing. While it
might seem more personal, the construction of new homes contributes to economic activity and
employment, making it a critical component of economic investment.
3.Public Investment : Government spending on infrastructure projects (like roads, bridges, and public
buildings), education, and healthcare facilities falls under this category. Public investment is vital for
creating the necessary conditions for economic growth.
4.Foreign Direct Investment (FDI): FDI occurs when a company or individual from one country makes
an investment into physical assets or a company in another country. FDI plays a key role in global
economic integration, transferring capital, skills, and technology across borders, and fostering
international economic growth.
Financial Investment
Financial investment encompasses a broad array of avenues where individuals and institutions allocate
capital with the expectation of achieving positive returns over time.
Unlike economic investment, which focuses on the acquisition of physical capital for future production,
financial investment is directed towards assets in financial markets, such as stocks, bonds, mutual funds,
and derivatives.
Instruments of Financial investment
1. Equities (Stocks)
Representing ownership stakes in corporations, equities are prized for their potential to yield substantial
returns through capital appreciation and dividends. However, they are subject to market volatility and
business performance risks.
2.Fixed Income Securities(Bonds): These are debt instruments issued by corporations and governments,
offering regular interest payments and principal repayment at maturity. Bonds are generally considered
lower risk than stocks, appealing to those seeking steady income.
3.Mutual Funds and Exchange Traded Funds (ETFs)
Pooling money from multiple investors to investors to invest in a diversified portfolio of stocks, bonds, or
other assets, these funds offer diversification and professional management.
ETFs, traded like stocks, combine the features of Mutual funds with the liquidity of equities.
4. Derivatives
Including options, futures, and swaps, derivatives are complex instruments derived from the value of
underlying assets.
They are used for hedging risk or speculative purposes but carry high risk and complexity.
5. Real Investment Trusts (REITs)
Allowing investment in real estate portfolios, REITs offer liquidity and income through dividends,
representing an alternative to direct property investment.
6. Commodities
Direct investment in physical goods like gold, oil, and agricultural products, or indirectly through futures
contracts, offers a hedge against inflation and portfolio diversification.
Speculation
Speculation is an investment decision which carries a high degree of risk . The investor or trader wishes
to profit from price fluctuation by speculating.
Speculation is a financial action that does not promise safety of the initial investment along with the
return on the principal sum.
Speculator the person tend to buy the assets with the expectation that a profit can earned from subsequent
price change and sale.
Investment V/s Speculation
Investment Speculation
Short-term bets on financial assets to gain
Definition Money allocation for an asset purchase.
quickly.
The investor’s main objective is to achieve
The speculator seeks to achieve small profits in
Aim small recurring returns in the long term,
the short term.
such as the payment of dividends.
Generally, the investor keeps the assets in
Speculators usually change assets in the short
Time his portfolio for a long time, years and
term, in minutes, hours, or a few days.
even a lifetime.
Thorough analysis of fundamental factors,
including company ratios, competitive and Technical analysis mainly combined with
Analysis
industry conditions, and technical factors fundamental and market sentiment.
throughout the asset’s history.
Income
Stable. Erratic.
Certainty
High risk. The higher the
Moderate risk. The lower the risk, the
Risks risk, the higher the potential
lower the return.
gains.
Features of Good Investment :
A good investment exhibits several key characteristics that help assess its potential for generating returns
and minimizing risks. Here are some fundamental traits that define a promising investment:
1. Positive Expected Return: A good investment offers the potential for positive returns over time.
This return should ideally outpace inflation and provide growth on the invested capital.
2. Manageable Risk: While all investments carry some level of risk, a good investment involves an
acceptable level of risk relative to the potential return. Diversification, thorough research, and
understanding risk factors are crucial in managing this aspect.
3. Liquidity: The ability to convert an investment into cash quickly without significant loss is
important. Liquidity ensures that you can access funds when needed without compromising the value of
your investment.
4. Stability and Consistency: Investments that demonstrate stability and consistency in
performance over time are considered favorable. This can include consistent dividend payouts,
predictable growth patterns, or stable market value.
5. Transparency and Information Accessibility: A good investment provides clear and readily
available information about its fundamentals, operations, financial health, and market trends.
Transparency helps investors make informed decisions.
6. Alignment with Goals and Strategy: An investment should align with an individual's or
institution's goals, time horizon, and risk tolerance. For instance, short-term goals may favor more liquid
and less volatile investments, while long-term goals may accommodate higher risk for potential higher
returns.
7. Tax Efficiency: A good investment minimizes the impact of taxes, either through tax-deferred
growth (such as retirement accounts) or by being structured in a way that reduces tax liabilities.
8. Quality Management or Governance: Investments in companies or ventures benefit from strong
leadership, effective management, and good corporate governance. A company's management quality
often directly influences its performance and potential for growth.
9. Scalability and Growth Potential: Investments with potential for growth and scalability offer the
possibility of increasing returns over time. Factors like market demand, innovation, and adaptability
contribute to this aspect.
10. Cost-Effectiveness: Minimizing expenses associated with an investment, such as management
fees, transaction costs, or operational expenses, is essential. Lower costs can enhance overall returns.
11. Environmental, Social, and Governance (ESG) Factors: Increasingly, investors consider an
investment's impact on environmental, social, and governance factors. Investments that exhibit
responsible practices and sustainable approaches often attract favor due to their long-term viability.
12. Adaptability to Market Conditions: A good investment can withstand various market conditions
and economic cycles. It might not be overly susceptible to short-term fluctuations and can endure
changing trends.
In summary, a good investment involves a blend of factors encompassing returns, risk
management, liquidity, stability, alignment with goals, transparency, quality management, growth
potential, cost-efficiency, ESG considerations, and adaptability to market changes. Finding the right
balance among these characteristics is key when evaluating investment opportunities.
Investment Process/ Stages :
The investment process involves a series of activities leading to the purchase of securities or other
investment alternatives. The investment process can be divided into five stages: (i) framing of the
investment policy, (ii) investment analysis, (iii) valuation, (iv) portfolio construction, and (v) portfolio
evaluation.
1. Framing of the Investment Policy : For systematic functioning, the government or investor,
formulates the investment policy before proceeding to invest. The essential ingredients of the policy are
investible funds, objectives and knowledge about investment alternatives and the market.
a.Investible funds : The entire investment procedure revolves around the availability of investible funds.
Funds may be generated through savings or from borrowings. If the funds are borrowed, the investor
has to be extra careful in the selection of investment alternatives. He must make sure that the returns are
higher than the interest he pays. Mutual funds invest their stockholders & in money in securities.
b.Objectives : The objectives are framed on the premises of the required rate of return, need for regular
income, risk perception and the need for liquidity. The risk takers objective is to earn a high rate of
return in the form of capital appreciation, whereas the primary objective of the risk-averse is the safety
of principal.
c. Knowledge : Knowledge about investment alternatives and markets plays a key role in policy
formulation. Investment alternatives range from security to real estate. The risk and return associated with
investment alternatives differ from each other. Investment in equity is high-yielding but faces more risk
than fixed income securities. Tax sheltered schemes offer tax benefits to the investors. The investor
should be aware of the stock market structure and functions of the brokers. The modes of operations are
different in the Bombay Stock Exchange (BSE), National Stock Exchange (NSE), and Over- the-Counter
Exchange of India (OTCEI). Brokerage charges are also different. Knowledge about stock exchanges
enables an investor to trade the stock intelligently.
2.Security Analysis : Securities to be bought are scrutinized through market, industry and company
analyses after the formulation of investment policy.
a. Market analysis The stock market mirrors the general economic scenario. The growth in gross
domestic product and inflation is reflected in stock prices. Recession in the economy results in a bear
market. Stock prices may fluctuate in the short-run but in the long-run, they move in trends, i.e., either
upwards or downwards. The investor can fix his entry and exit points through technical analysis.
b. Industry analysis : Industries that contribute to the output of major segments of the economy vary in
their growth rates' overall contribution to economic activity. Some industries grow faster than the
GDP and are expected to continue in their growth. For example, the information technology industry has
experienced a higher growth rate than the GDP in 1998. The economic significance and the growth
potential of the industry have to be analysed.
c. Company analysis : The purpose of company analysis is to help the investors make better decisions.
The company& its earnings, profitability, operating efficiency, capital structure and management have to
be screened. These factors have a direct bearing on stock prices and investors& returns. The appreciation
of stock value is a function of the performance of the company. A company with a high product market
share is able to create wealth for investors in the form of capital appreciation.
3. Valuation: Valuation helps the investor determine the return and risk expected from an investment in
Common stock. The intrinsic value of the share is measured through the book value of the share and price
earning ratio Simple discounting models also can be adopted to value the shares. Stock market analysts
have developed many advanced models to value shares. The real worth of the share is compared with the
market price, and investment decisions are then made. Future value. The future value of securities can be
estimated by using a simple statistical technique like trend analysis. The analysis of the historical
behaviour of price enables the investor to predict the future value.
4.Construction of a Portfolio : A portfolio is a combination of securities. It is constructed in a manner
so as to meet the investor& its goals and objectives. The investor should decide how best to reach the
goals with the securities available. The investor tries to attain maximum return with minimum risk.
Towards this end, he diversifies his portfolio and allocates funds among the securities.
Diversification : The main objective of diversification is the reduction of risk in the form of loss of
capital and income. A diversified portfolio is comparatively less risky than holding a single portfolio.
Several modes are available to diversify a portfolio. Debt and equity diversification Debt instruments
provide assured returns with limited capital appreciation. Common stocks provide income and capital
gain but with a flavour of uncertainty. Both debt instruments and equity are combined to complement
each other. Industry diversification Industries& growth and their reaction to government policies differ
from each other. Banking industry shares may provide regular returns but with limited capital
appreciation. Information technology stocks yield higher returns and capital appreciation, but their growth
potential in the post- global crisis years was unpredictable. Thus, industry diversification is needed, and it
reduces the risk. Company diversification Securities from different companies are purchased to reduce the
risk. Technical analysts suggest that investors buy securities based on price movement. Fundamental
analysts suggest the selection of financially sound and investor-friendly companies. Selection Securities
have to be selected based on the level of diversification, industry and company
analyses. Funds are allocated for selected securities. Selection of securities and the allocation of funds
seal the construction of portfolio.
6. Evaluation : A portfolio has to be managed efficiently. Efficient management calls for evaluation of
the portfolio. This Appraisal The return and risk performance of security varies from time to time. The
variability in returns of securities is measured and compared. Developments in the economy, industry and
relevant companies from which stocks are bought have to be appraised. The appraisal warns of the loss
and steps can be taken to avoid such losses. It depends on the results of the appraisal. Low-yielding
securities with high risk are replaced with high-yielding securities with low risk factor. The investor
periodically revises the components of the portfolio to keep the return at a level.
Instruments of Money Market:
The Indian money market comprises various financial instruments that are used for short-term borrowing,
lending, and investment. Here are some of the key instruments in the Indian money market, along with
their features:
1. Government and Semi-Government Instruments:
Government Securities (G-Secs): These are long-term debt instruments issued by the Government of
India. G-Secs come with varying maturities, and they are considered one of the safest investments in the
market because they are backed by the government.
Semi-Government Bonds: These are debt instruments issued by entities that are partially owned by the
government, such as state government bonds or bonds issued by government-backed institutions like
National Bank for Agriculture and Rural Development (NABARD) or Power Finance Corporation (PFC).
2. Treasury Bills (T-Bills):
Treasury bills are short-term government securities with maturities typically ranging from 91 days, 182
days, and 364 days.
T-Bills are issued at a discount to their face value and redeemed at face value upon maturity. The
difference between the purchase price and face value represents the interest earned.
3. Repo (Repurchase Agreements):
Repo is a short-term lending and borrowing mechanism in which one party sells securities (typically
government securities) to another party with an agreement to repurchase them at a specified future date
and price.
It is often used by banks and financial institutions to manage their liquidity and meet short-term funding
requirements.
4. Unit Trust of India (UTI) Units:
UTI units are investment units offered by the Unit Trust of India and other mutual fund companies.
These units represent ownership in a mutual fund, which pools money from investors and invests it in
various securities like stocks, bonds, and money market instruments.
5. PSU (Public Sector Undertaking) Bonds:
PSU bonds are debt instruments issued by public sector companies or undertakings in India.
These bonds offer a fixed interest rate and are considered relatively safe due to the backing of
government-owned entities.
The Indian money market consists of various instruments, both private and government, that facilitate
short-term borrowing, lending, and liquidity management. Private instruments in the Indian money
market include:
6. Commercial Bills: Commercial bills, also known as trade bills or bills of exchange, are
short-term promissory notes issued by sellers (creditors) to buyers (debtors) in the course of a trade
transaction. These bills can be discounted by banks to provide short-term funds to businesses.
7. Commercial Papers (CP): Commercial papers are unsecured promissory notes issued by
well-established corporations to raise short-term funds. They are typically issued for maturities ranging
from 7 days to one year and are a common instrument for short-term corporate financing.
8. Certificate of Deposit (CD): Certificate of Deposit is a time deposit offered by banks and
financial institutions to individuals and corporations. These deposits have a fixed maturity date and
typically offer higher interest rates than regular savings accounts.
9. Participation Certificate (PC): Participation certificates are issued by financial institutions as a
means of raising funds. They represent fractional ownership of a pool of assets, such as loans or leases,
and are typically bought by other financial institutions.
10. Factoring Bill: Factoring is a financial arrangement where a business sells its accounts receivable
to a third party (factor) at a discount. The factor provides immediate cash to the business in exchange for
the future receivables.
11. Interbank Instruments and Call Money Deposit: Interbank instruments include various
short-term lending and borrowing mechanisms between banks in the money market. Call money deposits
are short-term deposits made by one bank with another, usually for a period of one day.
12. Inter-corporate Instruments and Deposits: Inter-corporate instruments refer to short-term
financial instruments used by corporations to raise funds from other corporations. This can include loans,
inter-corporate deposits, and commercial paper transactions among companies.
Capital Market
Capital market is a place where the medium-term and long-term financial needs of business and other
undertakings are met by financial institutions which supply medium and long-term resources to
borrowers.
Capital market consists of shares, stocks, debentures and bonds. Securities dealt in capital market are
long- term securities. The funds which flows into the capital market comes from the savers. It provides a
market mechanism for those who have savings and to those who need funds for productive investments.
It diverts resources from wasteful and unproductive channels to productive investments.
Instruments issued in Capital Market
1. Debt instruments:
● A debt instrument is used by either companies or govts to generate funds for capital- intensive
projects.
● It can be obtained either through the primary or secondary market.
● It is an asset that individuals, companies and governments use to raise capital or to generate
investment income.
2. Equities (Common stock)
● Stocks represent ownership in a company. When you buy a stock, you become a shareholder and
own a portion of the company. Shareholders have the potential to benefit from the company's
profits in the form of dividends and capital appreciation.
● They are called as ordinary shares or common stock or voting share.
● The return on equity shares depends on the performance profitability of the company.
3. Preference Shares
● Preference shares are known as preferred stock.
● Preference share capital has two priorities that is in the repayment of capital and payment of
dividend.
● Preferred stocks usually carry no voting rights.
4. Debentures
● When a corporation is in need of funds in addition to share capital it borrows money by issuing
debentures.
● The debenture holder gets interest which is fixed at the time of issue.
5. Bonds
● Bonds are issued by public authorities, credit institutions, companies and super national
institutions in the primary market.
● A Bond is a negotiable certificate which entitles the holder of repayment of the principal sum plus
interest.
● The most common process of issuing bonds is through underwriting.
6. Mutual Fund
● It is an investment vehicle that is made up of a pool of funds collected from many investors for the
purpose of investing in securities such as stocks, bonds , money market instruments and similar
assets.
Derivatives
A Derivative is a financial instrument whose value is derived from the value is derived from the value of
another asset, which is known as the underlying. When the price of the underlying changes, the value of
the derivatives also changes. A Derivative is not a product. It is a contract that derives its value from
changes in the price of the underlying.
Example: The value of a gold futures contract is derived from the value of the underlying asset i.e gold.
The underlying assets could be equities (shares), debt (bonds, T-bills), currencies, and even indices of
these various assets, such as the Nifty 50 index.
Derivatives contracts are bought and sold by a large number of individuals, institutions and other’s for a
variety of purposes.
Classification of Derivatives.
1. Forward Contract:
A Forward contract or simply a forward is a contract between two parties to buy or sell an asset at a
certain future date for a certain price that is pre-decided on the date of the contract.
The future date is referred to as expiry date and the price-decided price is referred to as Forward Price.
It is the customized contract, in the sense that the term of the contract are agreed upon by the individual
parties.
Hence it is traded on Over The Counter (OTC)
2. Future Contract
Like a forward contract, a futures contract is an agreement between two parties in which the buyer agrees
to buy an underlying asset from the seller, at a future date at a price that is agreed upon today.
Unlike a forward contract, a futures contract is not a private transaction but gets traded on a recognized
stock exchange. In addition, a futures contract is standardized by the exchange.
Both buyer and seller of the futures contracts are protected against the counter party risk by an entity
called the clearing Corporation.
3. Options
Like forward and futures, options are derivative instruments that provide the opportunity to buy or sell an
underlying asset on a future date. There are two types of options.
A. Call Option
B. Put Option
Call Option:
Call option gives the buyer the right but not the obligation to buy a given quantity of the underlying
assets, at a given price on or before a given future date.
Put Option: Put gives the buyer the right but not obligation to sell a given quantity of the underlying
asset at a given price on or before a given date.
4. SWAPS
Swaps are private agreement between two parties to exchange cash flows in the future according to pre
arranged formula. They can be regarded as portfolio’s of forward contract.
a. Interest rate swaps: A Company agrees to pay a pre-determined fixed interest rate on a notional
principal for a fixed number of years.
b. Currency Swaps: It is a swap that includes exchange of principal and interest rates in one currency
for the same in another currency.
It is considered to be a foreign exchange transaction.
It is not required by law to be shown in the balance sheet.
The principal may be exchanged either at the beginning or at the end of the future.
