Chapter - One

1. Introduction
1.1. Definition of Investment
Investment is the employment of funds with the aim of getting return on it. In general terms,
investment means the use of money in the hope of making more money. In finance investment
means the purchase of a financial product or other item of value with an expectation of
favourable future returns. Investment of hard earned money is a crucial activity of every human
being. Investment is the commitment of funds which have been saved from current consumption
with the hope that some benefits will be received in future. Thus, it is a reward for waiting for
money. Savings of the people are invested in assets depending on their risk and return demands.

Investment refers to the concept of deferred consumption, which involves purchasing an asset,
giving a loan or keeping funds in a bank account with the aim of generating future returns.
Various investment options are available, offering differing risk-reward tradeoffs. An
understanding of the core concepts and a thorough analysis of the options can help an investor
create a portfolio that maximizes returns while minimizing risk exposure.
More specifically, investment is the current commitment of money/funds for a period of
time in order to derive future payments that will compensate the investor for
(1) The time the funds are committed,
(2) The expected rate of inflation, and
(3) The uncertainty of the future payments
ECONOMIC INVESTMENT AND FINANCIAL INVESTMENT
When a person invests his funds for the acquisition of some physical assets, say a building or
equipment, such types of investments are called economic investments. Economic investment
can be defined as the investment that contributes to the net additions to the capital stock of
society. Capital stock refers to the goods and service that are used in the production of other
goods and services. Hence, in short, it can be said that economic investments help create physical
assets directly.
When a person invests his funds for the acquisition of some financial assets like shares,
debentures, insurance policies, mutual fund units etc, and such investments are known as
financial investments. Financial investments also help in creating physical assets, but indirectly.

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Hence, economic investment and financial investment are inter-related. Increase in financial
investment leads to increase in capital stock. When an investor invests in a financial asset, he
indirectly invests in an underlying physical asset, since the financial investments are ultimately
used in creation of physical assets.
INVESTMENT V/s SPECULATION
Both investment and speculation are somewhat interrelated. It is said that speculation requires
investment and investments are to some extent speculative. Speculation is the purchase or sale
of anything in the hope of profit from anticipated changes in price. Both investment and
speculation aim at realizing income and capital appreciation. Yet, differences exist in terms of
expectation, risk and period of time.
INVETMENT
 The investor invest for long term gain purpose
 The investor holds securities for long period.
 Risk is less as compared to speculation
 The rate of return is less as compare to speculation
SPECULATION
 The investor invest for short term gain purpose
 The investor hold securities very short period say 1 or 2 days
 Risk is high
 Rate of return is more
 It involve buying and selling of securities
GAMBLING VS INVESTMENT
As against investment and speculation, gambling is unplanned. A gamble is usually a very short
term investment in a game or chance. It is an act of creating artificial and unnecessary risks for
expected increased return. Gambling is undertaken just for trill and excitement. There is no risk
and return trade off in the gambling and the negative outcomes are expected. But in the
investment there is an analysis of risk and return.
In short, gambling involves acceptance of extra ordinary risks even without a thorough
knowledge about them for pecuniary gains. Playing cards, lottery etc., are some typical examples
of gambling.
3. Participants in investment process

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The three key participants in the investment process are government, business and individuals.
a. Government: In cases where the operating expenditures exceed government revenues or if
government receipts are not yet available to meet government payments, government resorts
to borrowing funds by issuing short-term debt securities.
Funds are needed to finance capital expenditures like long-term infrastructure projects – road
building, schools and hospitals through the issuance of different types of long-term debt
securities. If government has temporary idle cash, it sometimes makes short-term
investments to earn positive returns.
b. Business: On the short-term, funds are used to meet operating cost like financing inventory
and accounts receivables. Long-term needs of businesses are concentrated on seeking funds
to develop products, build plants and buy equipment. Financing these needs require
businesses to issue a variety of debt and equity securities. Business firms also supply funds if
they have excess cash. At the same time, they are both net demanders of fund since they
demand more funds than they supply.
c. Individuals: They supply funds to help meet the needs of both government and businesses
through deposits in savings accounts, purchases of debt or equity securities, buy insurance or
various types of property. As a group, individuals are net suppliers of funds; they put money
into the financial system than they take out.
Different Alternatives of Investment
Investment in any of the alternatives depends on the needs and requirements of the investor.
Corporate and individuals have different needs. Before investing, these alternatives of
investments need to be analyzed in terms of their risk, return, term, convenience, liquidity etc.
1. Equity Shares
Equity investments represent ownership in a running company. By ownership, we mean share in
the profits and assets of the company but generally, there are no fixed returns. It is considered as
a risky investment but at the same time, they are most liquid investments due to presence of
stock markets.
2. Debentures or Bonds
Debentures or bonds are long term investment options with a fixed stream of cash flows
depending on the quoted rate of interest. Amount of risk involved in debentures or bonds is

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dependent upon who the issuer is. For example, if the issuer is government, the risk is assumed
to be zero. Following alternatives are available under debentures or bonds:
 Savings bonds
 Debentures of private sector companies
 Preference shares
3. Money Market Instruments
Money market instruments are just like the debentures but the time period is very less. It is
generally less than 1 year. Corporate entities can utilize their idle working capital by investing in
money market instruments. Some of the money market instruments are:
 Treasury Bills  Certificate of Deposits
 Commercial Paper
4. Mutual Funds
Mutual funds are an easy and tension free way of investment and it automatically diversifies the
investments. Mutual fund is an investment mix of debts and equity and ratio depending on the
scheme. They provide with benefits such as professional approach, benefits of scale and
convenience. In mutual funds also, we can select among the following types of portfolios:
 Equity Schemes  Balanced Schemes
 Debt Schemes  Sector Specific Schemes etc.
5. Life Insurance
Life insurances are one of the important parts of investment portfolios. Life insurance is an
investment for security of life. The main objective of other investment avenues is to earn return
but the primary objective of life insurance is to secure our families against unfortunate event of
our death. It is popular in individuals. Other kinds of general insurances are useful for corporate.
There are different types of insurances which are as follows:
 Endowment Insurance Policy  Term Insurance Policy
 Whole Life Policy
6. Real Estate
Every investor has some part of their portfolio invested in real assets. Almost every individual
and corporate investor invests in residential and office buildings respectively. Apart from these,
others include:
 Agricultural Land  Semi-Urban Land

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  Commercial Property  Farm House etc
 Raw House
7. Precious Objects
Precious objects include gold, silver and other precious stones like diamond. Some artistic
people invest in art objects like paintings, ancient coins etc.
8. Financial Derivatives
Derivatives mean indirect investments in the assets. Derivatives market is growing at a
tremendous speed. The important benefit of investing through derivatives is that it leverages the
investment, manages the risk and helps in doing speculation. Derivatives include:
 Forwards  Options
 Futures  Swaps etc
9. Non Marketable Securities
Non marketable securities are those securities which cannot be liquidated in the financial
markets. Such securities include:
 Bank Deposits  Provident Fund Deposits
 Company Deposits
Objectives and Characteristics of investment

Objectives of investment
Every investor has certain specific objective to achieve through his long term or short term
investment. Such objectives may be monetary/financial or personal in character.
The Three financial objectives are:-
1. Safety & Security of the fund invested (Principal amount)
2. Profitability (Through interest, dividend and capital appreciation)
3. Liquidity (Convertibility into cash as and when required)
These objectives are universal in character as every investor will like to have a fair balance of
these three financial objectives. An investor will not like to take undue risk about his principal
amount even when the interest rate offered is extremely attractive. These factors are known as
investment attributes. There are personal objectives which are given due consideration by every
investor while selecting suitable avenues for investment. Personal objectives may be like
provision for old age and sickness, provision for house construction, provision for education and

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marriage of children. Investment Avenue selected should be suitable for achieving both the
financial and personal objectives.

Characteristics of financial assets

As our focus is investment in financial assets the following section presents the important
characteristics of investment in this type of assets compared with investments in physical assets;
 Financial assets are divisible, whereas most physical assets are not. An asset is divisible if
investor can buy or sell small portion of it. In case of financial assets it means, that investor,
for example, can buy or sell a small fraction of the whole company as investment object
buying or selling a number of common stocks.
 Marketability (or Liquidity) is a characteristic of financial assets that is not shared by
physical assets, which usually have low liquidity. Marketability (or liquidity) reflects the
feasibility of converting of the asset into cash quickly and without affecting its price
significantly. Most of financial assets are easy to buy or to sell in the financial markets.
 The planned holding period of financial assets can be much shorter than the holding period of
most physical assets. The holding period for investments is defined as the time between
signing a purchasing order for asset and selling the asset. Investors acquiring physical asset
usually plan to hold it for a long period, but investing in financial assets, such as securities,
even for some months or a year can be reasonable. Holding period for investing in financial
assets vary in very wide interval and depends on the investor’s goals and investment strategy.
 Information about financial assets is often more abundant and less costly to obtain, than
information about physical assets. Information availability shows the real possibility of the
investors to receive the necessary information which could influence their investment
decisions and investment results. Since a big portion of information important for investors in
such financial assets as stocks, bonds is publicly available, the impact of many disclosed
factors having influence on value of these securities can be included in the analysis and the
decisions made by investors.

Selecting investment in global markets

 Reasons for global investing

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  More investment opportunities
 Better rates of returns
 Greater potential for diversification
 Global Investment Choices
 Fixed-income investments
 Equity investments
 Forward and Futures contracts
 Real assets
 Low-liquidity investments
Securities Market (Financial Markets)
Financial markets are designed to allow corporations and governments to raise new funds and to
allow investors to execute their buying and selling orders. In financial markets funds are
channeled from those with the surplus, who buy securities, to those, with shortage, who issue
new securities or sell existing securities. A financial market can be seen as a set of arrangements
that allows trading among its participants.
Investment in securities represents either a debt or an equity interest. Debt represents funds
borrowed in exchange for receiving interest income and the promise that the loan will be repaid
at a given future date. Bonds and commercial papers are example of debt securities. Equity
represents a current ownership interest in a specific business or property. Typically, an investor
obtains an equity interest in a business by buying securities collectively known as stocks (i.e.,
common, preferred and convertible preferred).
Debt securities are similar to bank loans, in that the corporation promises to pay the face value
on the maturity date together with interest payments at regular intervals. But unlike a bank loan,
bonds and commercial papers are represented by certificates, which are handed over to the buyer
who becomes the holder of the certificates. In this way, stocks are also similar to debt securities
– a stock certificate is issued – but differs in a way that the issuing company does not have the
obligation to pay interest to the holder or repay the face value of the stock.
The Role of Financial Markets
Financial markets provide three economic roles. First, the interactions of buyers and sellers in
a financial market determine the price of the traded assets; or equivalently, the required
return on a financial asset is determined. The inducement for firms to acquire funds depends

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on the required return that investors demand, and it is this feature of financial markets that
signals how the funds in the economy should be allocated among financial assets. This is called
the price discovery process.

Second, financial markets provide a mechanism for investor to sell a financial asset. Because
of this feature, it is said that a financial market offers liquidity, an attractive feature when
circumstances either force or motivate an investor to sell. In the absence of liquidity, the owner
will be forced to hold a debt instrument until it matures and an equity instrument until the
company is either voluntarily or involuntarily liquidated. While all financial markets provide
some form of liquidity, the degree of liquidity is one of the factors that characterize different
markets.
The third economic role of a financial market is that it reduces the search and
information costs of transacting. Search costs represent explicit costs, such as the
money spent to advertise the desire to sell or purchase a financial asset, and implicit costs, such
as the value of time spent in locating counterparty. The presence of some form of organized
financial market reduces costs. Information costs are those entailed with assessing the investment
merits of financial assets; that is, the amount and the likelihood of the cash flow expected to be
generated. In an efficient market, prices reflect the aggregate information collected by all market
participants.
Participants of financial market
Participants of financial market can be broadly grouped in to two: Lenders & Borrowers
 Lenders (surplus unit): it includes individuals and corporations with capital in excess of
their current requirement.
 Individual savers: A person lends money when he/she puts money in a saving or fixed
account at a bank; contributes in a pension plan; pays premiums to an insurance
company; invest in a government bonds; or invest in a company shares.
 Firms/Companies: those having surplus cash which is not needed for a short period of
time, they may seek to make money from their cash surplus by lending it via short term
market called money market.
 Borrowers (deficient units); includes individuals, companies, central or local government,
public corporations or institutions with different investment opportunities (expansion,
replacement, additions or making new investment), but lack adequate internal capital to

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 finance their investment.
 Individual borrowers: borrow money via banker’s loans for short term needs or longer
term mortgage to help finance a house purchases.
 Government: borrow to finance their deficit and to on behalf of nationalized industries,
local authorities, municipalities and other public sectors.
 Municipalities and local authorities: may borrow in their own name as well as
receiving fund from national governments.
 Companies: firms those having deficit of fund needs money to finance their operation.
 Public corporations: these may include governmental owned service providers with
customer charging basis: such as, public enterprise, utility companies, etc.
Classification of Financial Markets
Now that we understand the basic role and participants of financial markets, let’s look at their
structure. The following descriptions of several categorizations of financial markets illustrate
essential features of these markets.
1. On the basis of financial claim
A. Equity (stock) market: deals with variable income securities
B. Bond (debt) market: deals with fixed income securities
2. On the basis of maturity of security traded (period)
A. Money market; which provides short term debt financing and investment.
B. Capital market: the market for debt and equity instruments with a maturity of more
than one year.
3. On the basis of time of delivery
A. Spot market: market for immediate delivery
B. Future/forward market: a market in which delivery is after certain future time
4. On the basis of by origin
A. Primary market: markets dealing with financial assets that are issued for first time
(deals with newly issued securities).
B. Secondary market: markets deals with previously issued financial instruments.
5. On the basis of market structure:
A. Auction market: market on the floor of stock exchange

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 B. Over-the-counter (OTC) market: market by interconnected computers. That is, it
does not denote a particular place where dealers assemble and transact securities.
6. Other classifications:
A. Derivatives market: this provides instruments or the management of financial
market.
B. Foreign exchange market: deals with the trading of foreign currency
C. Commodity market: deals with the trading of commodities (agricultural and
industrial products; such as precious metals)

Debt Markets vs. Equity Markets

Another way of classifying financial markets is based on the type of claim associated with the
fund transferred through the transaction in that market. Accordingly, if the transaction represents
a simple borrowing and does not give ownership title to the buyer of the security, the market is
termed as debt market. For example, a firm may raise fund by issuing a debt instrument, such as
a bond or a mortgage, which is a contractual agreement by the borrower to pay the holder of
instrument fixed dollar amounts at regular intervals (interest and principal payments) until a
specified date (the maturity date), when a final payment is made. The buyer of the debt
instrument will then will get his money with some return. In cases of loss or bankruptcy, he will
have first claim over the assets of the firm. This means, if the firm that issues the instrument
went bankrupt and could not pay its debt, the holder of the instrument has the right to enforce the
firm to liquidate its assets and get his money. On the other hand, the holder of the instrument will
not have ownership title over the firm and hence his return will not depend on the profitability of
the firm.
In contrast, if the transaction gives ownership title to the buyer of the instrument, the market is
termed as equity market. In this case, the buyer of the financial asset will be one of the owners
of the firm and unlike in the case of debt market he will not expect a predetermined return. He
will rather expect to get a series returns in terms of dividend and capital gain. Thus, unlike the
buyer of a debt instrument, his return will depend on the profitability of the firm and in case of
bankruptcy he will have a residual claim like the other owners of the firm.
Money vs. Capital Markets
Another way of distinguishing between financial markets is on the basis of the maturity of the
securities traded in each market. The money market is a financial market in which only short-

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term debt instruments (maturity of less than one year) are traded. Capital market is the market in
which long-term debt (maturity of one year or greater) and equity Instruments are traded. Money
market securities are usually more widely traded than longer-term securities and so tend to be
more liquid.
A. Money Market
The money market is where short-term debts such as treasury bills (TB), commercial paper,
banker’s acceptance…etc are bought and sold. Participants borrow and lend for short periods of
time, typically up to one year.

Money market is the term designed to include the financial institutions which handle the
purchase, sale & transfers of short term credit instruments. It includes the entire machinery for
the channelizing of short term funds.
Characteristics of money market
The general characteristics of a money market are given below:
i) Short term funds are borrowed & lent
ii) No fixed place for conduct of operations, the transaction being conducted even over the
horizontal & therefore there is an essential need for the presence of well developed
communications system.
iii) Dealings may be conducted with or without the help of brokers.
iv) Funds are traded for a maximum period of one year.

B. Capital Markets
Capital market is the market in which intermediate or longer-term debt (generally those with
original maturity of more than one year) and equity instruments are traded. In capital market,
firms commonly issue securities such as stocks and bonds to finance their long-term investments
in corporate operations and the government also issues debt securities in this market. Institutional
and individual investors purchase securities with funds that they wish to invest for a longer time.
Even though stocks do not have maturities, they are classified as capital market securities
because they provide long-term funding. The New York Stock Exchange, where the stocks of the
largest U.S. corporations are traded, is a prime example of a capital market. However, when
describing maturity of debt securities in capital market, “intermediate term” means 1 to 10 years,
and “long term” means more than 10 years.
Spot Market vs. Future markets
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 Financial markets can also be classified based on the timing of the contract and the
transaction. Spot markets are markets where the transaction is made at the time of lag-on the
spot. For example, if we consider a spot foreign exchange market, the exchange will be made
at the time of agreement except for some short time lag in delivery like hours or maximum of
2 days. While future markets are markets where the contract is made today and
transaction/delivery is made in a future time specified in the contract. They are markets
where future contracts are traded.
 Future contracts are contracts which are agreements to deliver items on a specified future
date at a price specified today but not paid until delivery. To use the same example of a
foreign exchange market, a buyer and a seller may agree today to transact a foreign currency
after some time say three months at rate they fix now. Future markets are important to avoid
risk arising from fluctuations in the spot market.
Primary vs. Secondary Market
A. Primary Market
Primary market is a market in which newly-issued securities are sold to initial buyers by the
corporation or government borrowing the funds. Securities available for the first time are offered
through the primary market. That is, in the primary market, companies interact with investors
directly while in the secondary market investors interact with themselves.
The securities offered may be a new type for the issuer or additional amounts of a security used
frequently in the past. The company receives the money and issues new security certificates to
the investors.
The traditional middleman in the primary market is called an investment banker. Investment
banking firms play an important role in many primary market transactions by underwriting
securities: they guarantee a price for a corporation’s securities and then sell those securities to
the public. That is, it buys the new issue form the issuer at an agreed upon price and hopes to
resell it to the investing public at a higher price.
Usually, a group of investment bankers joins to underwrite a security offering and form what is
called an underwriting syndicate. Companies raise new capital in the primary market through:
a) Public issues ( initial public offering) or IPO
b) Right issue
c) Private placement

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  Public issue/ offering: The established companies may sell new securities directly to the
general public, i.e. to individuals and institutions.
 Right issue: Offering of securities may be made only to the existing shareholders. Thus,
when securities are offered only to the company’s existing shareholders buy, it is called
right issue.
 Private placement: Instead of public issue of securities, a company may offer securities
privately only to a few selected investors. This is referred to as private placement. The
investment bankers may act as a finder, that is, he locates the institutional buyer for a fee.
B. Secondary Market
The secondary market is also known as, the aftermarket, is the financial market where
previously issued securities and financial instruments such as stock and bonds are bought and
sold.
Secondary market is a market where already issued or existing or outstanding financial assets are
traded among investors. In the secondary market the issuer of the asset does not receive funds
from the buyer unlike primary market. Rather, the existing issue changes hands and funds flow
from the buyer of the asset to the seller in secondary market.
Function of secondary Market
In short it has the following are economic functions of secondary market both for the issuer and
investors:
Benefits to the issuers
Provides regular information about the value of the security.
For example, higher value of shares indicates- higher goodwill (public image) from the
investors’ point of view, good management of funds raised from earlier primary markets
by the firm.
Help determining fair prices based on demand and supply forces and all available
information.
Benefits to investors (buyers) or security holders.
Secondary market offers them high liquidity for their assets as well as information about
their assets fair market values.
They can sell their shares at readily available market.
Provide marketability and liquidity for investors

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 It helps investors feel confidence that they can shift from one financial asset to another.
Thus, by keeping the cost of both searching & transaction costs low, secondary market
encourages investors to purchases financial assets.
Auction Market vs. Over-The-Counter (OTC) Market
The other classifications of financial market can be made on the basis of structure of the market.
Accordingly, the following are the two major classifications.
Auction market: It is also called open outcry market. It is where some transactions are carried
out on a trading floor, by a method known as open outcry. This type of auction is used in stock
exchange and commodity exchanges where traders may enter “verbal” bids and offers
simultaneously.
Stock Exchange
Stock exchange are organized market places in which stocks and other securities are traded by
members of the exchange, acting as both agents (brokers) and principals (dealers or
traders).These exchanges are physical locations and are made up of members that use the
exchange facilities and systems to exchange or trade listed stocks. Stocks traded on an exchange
are said to be listed stocks. To be listed, a company must apply and satisfy requirements
established by the exchange for minimum capitalization, shareholder equity, average closing
share price and other criteria. Even after being listed exchanges may delist a company’s stock it
is no longer meets the exchange requirements.

The right to trade securities or make markets in an exchange floor is granted to a firm or
individual who becomes a member of the exchange by buying a seat on the exchange. The
number of seats is fixed by the exchange and the cost of a seat is determined by its demand and
supply.
Functions of stock exchange market
The stock exchanges perform a number of functions useful to both the investors and
corporations. They carry out the following functions.

i) Central trading place: they provide a central place where the brokers and dealers regularly
meet and transact business.
ii) Settlement of transaction: they provide convenient arrangements for the settlement of
transaction.
iii) Continuous market: these are markets for the existing securities. These are places for the
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 holder of securities to buy and sell their securities and for those who want to invest their
savings. The stock exchange thus provides liquidity to their investment.
iv) Supply of long term funds: since the securities can be negotiated and transferred through
stock exchanges, it becomes possible for the companies to raise long term funds from
investors. In the stock exchange, one investor is substituted by another when a security is
transacted. Therefore, the company is assured of long term availability of funds.
v) Setting up of rules and regulations: stock exchanges set up rules and regulations governing
the conduct and finance of their members. It ensures that a reasonable measure of safety is
provided to investors and the transactions take place under competitive conditions.
vi) Evaluation of securities: stock exchange helps to evaluate the securities as they publish the
prices of securities regularly in newspapers. They also enable the holders of securities to
know the worth of their holdings at any time.
vii) Control over company management: a company which wants to get its shares listed in a
stock exchange has to follow the rules framed by the stock exchange. Though these rules
and requirements, the stock exchanges exercise some control on the management of the
company.
viii) Helps capital formation: stock exchanges helps capital formation. The publicity given by
the stock exchanges about the different types of securities and their prices encourage even
the disinterested persons to save and invest in securities.
ix) Facilitates speculation: stock exchanges provides facilities for speculation and enables
shrewd businessmen to speculate in the market and make substantial profits.
x) Directs the flow of savings: a stock exchange directs the flow of savings of the community
between different types of competitive investments. It also helps to meet the investment
needs of entrepreneurs.
Over the Counter (OTC) market
The over-the-counter (OTC) is not physically existing market as that if stock exchange, but
transactions between traders are made electronically via network of computers. The OTC market
is also called the market for unlisted stocks. OTC market includes trading in all stocks not
listed on one of the exchanges. It can also include trading in listed stocks, which is referred to as
the third market. The OTC market is not a formal organization with membership requirements or
a specific list of stocks deemed eligible for trading. In theory, any security can be traded on the

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OTC market as long as a registered dealer is willing to make a market in the security (willing to
buy and sell shares of the stock).
There is tremendous diversity in the OTC market because it imposes no minimum requirements.
Stocks that trade on the OTC range from those of small, unprofitable companies to large,
extremely profitable firms.
As any stock can be traded on the OTC as long as someone indicates a willingness to make a
market whereby the party buys or sells for his/ her own account acting as a dealer. This differs
from most transactions on the listed exchanges, where some members act as brokers who attempt
to match buy and sell orders. Therefore, the OTC market is referred to as a negotiated market, in
which investors directly negotiate with dealers.
Derivatives markets
Derivatives markets are a market in which derivatives securities are bought and sold. What is a
derivatives security? A derivative security is a security whose value depends on the values of
other more basic underlying securities. Some contracts give the contract holder either the
obligation or the choice to buy or sell a financial asset. Such contracts derive their value from
the price of the underlying financial asset. Consequently, these contracts are called derivative
instrument.
The derivative securities are also known as contingent claims. Very often, the variables
underlying the derivative securities are the prices of traded securities. For example, a stock
option is a derivative security whose value is contingent on the price of a stock. The following
are the important derivative securities:
 Forward contracts  Futures contracts
 Options contracts
Forward contract
A forward contract is a simple derivative security. It is an agreement to buy or sell an asset at
certain future time for certain price. The contract is usually between either two financial
institutions or a financial institution and one of its corporate clients. It is not traded on a stock
exchange.
One of the parties to a forward contract assumes a long position and agrees to buy the underlying
security on certain specified future date for certain specified price. The other party assumes a
short position and agrees to sell the asset on the same date for the same price. A forward contract

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is settled at maturity. The holder of the short position delivers the security to the holder of the
long position in return for cash equal to the delivery price.
Option contract
Options are defined “marketable securities that give their owner the right but not the obligation
to buy or sell a stated number of shares at a fixed price within a per-determined time period . So,
it is a contract which involves the right to buy or sell securities at specified prices within a stated
time.
Options provide the investors with the opportunity to hedge investments in the underlying shares
and share portfolios and can, thus, significantly reduce the overall risk related to investments. In
addition, options contract increase liquidity
Future contracts
A futures contract is an agreement between two parties to buy or sell an asset at certain price at
certain time in the future. The futures contracts are normally traded on an exchange. The most
important feature of futures contract is that, as the two parties to the contract do not necessarily
know each other, the exchange also provides a mechanism which gives the two parties a
guarantee that the contract will be honored.

The distinction between futures and options

Futures
i) Futures create an obligation to make or take delivery at some future date.
ii) No payment is involved.
iii) Futures contracts are usually larger in value.
iv) They establish a price.
v) In the case of futures position, the loss can exceed the original margin commitment
Options
i) Options confer right but not the obligation to do the same.
ii) Premium paid on options is non-refundable.
iii) Options are smaller in value.
iv) Options set a range within or outside which a position proves profitable.
v) In the case of option position, the original deposit represents the maximum possible loss.
Foreign Exchange Market (FOREX) Market

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Different countries have different currencies and the settlement of all business transactions with
in a country is done in the local currency. However, the foreign exchange market provides a
forum where the currency of one country is traded for the currency of another country.

Example, suppose an Ethiopian importer import goods from the USA and has to make payments
in US Dollars. To do so, an Ethiopian importer has to purchase US Dollars in the foreign
exchange market and make payment to US firm/importer.

Therefore, the foreign exchange market is a market where foreign currencies are bought and
sold. Since foreign exchange market deals with a large volume of funds as well as a large
number of currencies (belonging to various countries), it is not only worldwide market but also
the world’s largest financial market.

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