What is investment

“Sacrifice of something now for the

prospect of some thing later”.
We forego the consumption of goods
today in order to achieve greater
consumption in future
The essence of investment is TIME
and also RISK
Investment definition-Hirt
and Block
 Commitment of current funds in
anticipation of receiving a larger future
flow of funds. The investor hopes to be
compensated for forgoing immediate
consumption, for inflation and for taking
risk
Investment management

 The professional management of various

securities (shares, bonds etc)
 assets (e.g. real estate), to meet
specified investment goals for the benefit
of the investors.
Who are the investors

 Investors may be
 institutions (insurance companies, pension
funds, corporations etc.)
 or private investors (both directly via
investment contracts and more commonly
via collective investment schemes e.g.
mutual funds) .
 Individuals
 Overview of the subject
 Investment Process consists of Two broad tasks
 1. Security and Market Analysis
(Investment Analysis)
- We assess the risk and expected return attributes of entire set of
possible investment vehicles
 2. The formation of optimal portfolio of assets
( Portfolio theory)
- Determination of the best risk-return opportunities available from
feasible investment portfolios
- Choice of the best portfolio from the feasible set
Overview of the course
 The course is about the investment of
resources in financial securities
 Investment is defined as a sacrifice made now
to obtain a return later
 It is current consumption that is sacrificed
 Two forms of investment can be defined
 Real investment is the purchase of land,
machinery, etc
 Financial investment is the purchase of a "paper"
contract
For instance
 Oilibya , Libiya’s Oil gaint siging an agreement to acquire 100% of
oil gaint, Shell petroleum Ethiopia and Djibouti Ltd.
 Tata Motars Ltd puts money into developing a new small car per
unit $2500
 Govt decided to invest in bahirdar to promote satelite launching
centre.
 DP World going to put $2 bln on Ethio-Djibouti Railway
 Kombolch textile share company expansion programme
 International Finance Corporation investment on MIDROC-
DERBA cement factory by providing loan
Real vs Financial Assets
 Real Assets:
 Productive capacity is a function of Real assets of the economy
 For ex: land and Buildings, Knowledge, Machines
 Physical and Human assets generate the entire spectrum of
output produced and consumed by the society
 Financial Assets:
 Do not directly contribute to the productive capacity of the
Economy
 Contribute indirectly to the productive capacity of the Economy
 These are allow to separation of ownership and Management
 Real vs Financial Assets
 Facilitate to transfer funds to enterprises with attractive investment
opportunities
 Contribute to the wealth of individuals or firms holding them
 These are claims to the income generated by real assets or claims on
income from the government
 These are derived from and depend on the values of the underlying
real assets of the firm ( Bonds ,equity stocks – residual claim)
 These assets are define the income or wealth among investors
When the investor prefer to invest for their future, they chose hold
financial assets
 These are facilitates to procure real assets
 These are the means by which individuals hold their claims on real
assets
 For ex: shares, bonds, t-bills, CDs, commercial Paper etc…
 Distinction between Real and
Financial Assets
 Financial assets are created and destroyed in the ordinary course of
business
 Real assets are destroyed only by accident or Wearing out overtime
 Presentation in the Balance sheet
Gains and Losses
 Some investments can be
very successful.
 $10,000 invested in August
1998 in Cephalon would have
been worth $107,096 in
September 2003 (and
$180,000 in 2007)
 £10,000 invested in
September 2001 in
Lastminute.com would have
been worth £134,143 in
August 2003
And Losses
 Losses in value can be even
more spectacular
 $10,000 invested in
September 2000 in Palm Inc.
would have been reduced to
$91 by April 2003
 A holding in July 2000 of £15
million in Exeter Equity
Growth Fund would have
been worth £72,463 in August
2003 (the share price fell from
103.50 to 0.50)
Financial Investment
 There are numerous components to financial
investment
 Markets: where assets are bought and sold, and the
forms of trade
 Securities: the kinds of securities available, their
returns and risks
 Investment process: the decision about which
securities, and how much of each
 Financial theory: the factors that determine the
rewards from investment (and the risks)
Markets
 A market is any organized system for
connecting buyers and sellers
 There are many security markets
 Markets may have a physical location
 The New York Stock Exchange
 May exist only as computer networks
 The London Stock Exchange
 Markets vary in the securities that are traded
and in the way securities are traded
Characteristics of Markets
 There are a number of ways to classify
markets
 Primary/Secondary
 Primary markets are security markets where new
issues of securities are traded
 A secondary market is a market where securities
are resold
 The London Stock Exchange is a secondary
market
 Most activity on stock exchanges is in the
secondary market
Characteristics of Markets
 Trades on the primary market raise capital for firms
 Trades on the secondary market do not raise additional
capital for firms
 The secondary market is still important
 It gives liquidity to primary issues. New securities would have
a lower value if they could not be subsequently traded
 It signifies value. Trading in assets reveals information and
provides a valuation of the assets. This helps to guide
investment decisions
Characteristics of Markets
 A second way to classify markets is the times
of trading
 Call/continuous
 In a call market trading takes place at a specified
time intervals
 Some call markets have a provision that limits
movement from the prior price. This is to prevent a
temporary order imbalance from dramatically
moving the price
 In a continuous market there is trading at all times
the market is open
Characteristics of Markets
 Markets can also be characterized by the
lifespan of the assets traded
 Money/Capital
 Money market: the market for assets with a life of
less than 1 year
 Capital market: the market for assets with a life
greater than 1 year
 Some assets, such as most bonds, have a
fixed lifespan
 Common stock have an indefinite lifespan
 Financial Markets and the
 Economy
1. Consumption Timing:
 How can we shift our purchasing power form high earnings periods to
low-earnings periods of life
 Some individuals in an economy are earnings more than they wish to
spend Ex: HNWIs
 One way is to Store our wealth in financial assets ex: stocks, bonds,
Long-term deposits, Insurance policy, pension funds, retirement benefit
schemes.
 Some individuals spend more than they currently earn
ex: Retirees, students perusing higher education
 We can sell financial assets to provide funds for our consumption
needs when ever in the Low earning periods
 “Financial markets allow individuals to separate decisions concerning
current consumption from constraints that otherwise would be imposed
by current earnings
 Financial Markets and the
Economy
2. Allocation of Risk
 Capital markets allow the risk that is inherent to all investments to
borne by the investors most willing to bear that risk
 Allocation of risk benefits the firm to raise capital to finance their
investments.
 Investors can self select into security types with risk-return
characteristics that best suit their preference
 All the above activities facilitates the process of building the economy’s
stock of real assets
3. Separation of ownership and Management:
 Global markets, Large scale production, huge markets, leads to capital
requirements of firms have skyrocketed .
 Owners and managers of the firm are different , this gives stability that
owner managed firm cannot achieve .
 Some stock holders decide they no longer wish to hold shares in the
firm, they can sell their shares to other investors, with impact on the
management of the firm .
Investment alternatives
 Financial Assets:
* Equity claims – Direct:
- common Stock
- Warrants
- Options
* Equity claims – indirect:
- Investment company shares
* Creditor Claims:
- Savings Accounts
- Money market funds
- Commercial Paper
- Treasury bills
- Bonds ( Straight and convertible to common stock)
- Preferred Stock ( Straight and convertible to common stock)
 Investment alternatives
 Real Assets:
 Real estate - Office building, Apartments, Shopping centers,
Personal residences
 Precious metals – gold and silver
 Precious gems - Diamonds, rubies, Sapphires
 Collectibles – Art, Antiques, Stamps, Coins, Rare
books
 Others- cattle, Oil, Common metals
 Key areas should consider before
investment
1. Risk and Safety of Principal
- Risk vs return , Loss of Purchasing power (Inflation)
- Age and Economic circumstances of an investor
- Gold vs Common Stock
2. Current income vs Capital appreciation
- Desire of current vs capital appreciation
3. Liquidity consideration
- Transaction costs/ commissions ( financial assets vs Real assets)
 Key areas should consider before
investment
4. Short-term vs Long-term orientation
- Managing funds
- Evaluating performance
- Funds who manage for others
- Market strategies: ( traders : technical analysis – short term)
- Buy and hold approach
5. Tax factors
- High tax bracket investors – Municipal bonds, real estate
- Lower tax bracket investors- High yield stocks/bonds
- Tax exempt charities – High yield short term instruments
6. Ease of Management
- Time & effort devoted
- Stock market – daily / long- term
- Real estate – Personally owning/ Rental houses
7. Retirement and Asset planning considerations
- Individual Retirement Account
 Investment Process
 5 step procedure
 1. Set investment policy:
- Investor objectives –stated both risk and return
- Amount his/her invest able wealth
- Tax status of investor
2. Security Analysis
- Examining no.of individual securities
- Identifying mis priced assets
A) Technical Analysis ( using charts and graphs trend observation)
B) Fundamental Analysis ( identify True value)
TV> Market value = Under priced
TV < Market value = over priced
 Investment Process
 3. Portfolio Construction
-identify specific assets to invest
- Determine the proportions of wealth in each asset
Three issues are concerned for
a) Selectivity/Micro forecasting :( movement of individual securities)
b) Timing / Macro forecasting :( movements of common stocks in
relation to fixed income securities)
c) Diversification :
Construction of portfolio in such a manners that risk is minimized ,
subject to certain restrictions
 Investment Process
4. Portfolio Revision
- periodic repetition of first three steps
- investor may change his objectives
- current portfolio may no longer optimal
- Selling some one and buying some other
* Transaction costs are need to consider
5. Portfolio Performance Evaluation
- Determine performance of portfolio periodically
- Not only return earned , risk exposed by investor
- Appropriate measure of Risk and Return
- Fix up relevant standards
Finance Theory
 Return : current income + capital gain
current income = income/ Beginning value
Capital gain = Ending value – beginning value/
Beginning
value
 Risk : variance , Standard deviation
 Variance : Sum of squares of the deviations of actual
return from the expected returns
 Standard deviation: Square root of variance
 Actual consideration of Required return
 1. The real rate of return
- investors require for allowing others to use their money
- investor demand for passing up immediate consumption and
allowing others to use their savings
- real means value determined before inflation is included in the
calculation
2. Anticipated inflation factor
Risk free rate = (1+Real rate) (1+Expected inflation factor) -1
3. Risk Premium
- It is different from each investment
- T-Bills and CDs at Bank – Risk premium will be ZERO
- For common stocks risk premium carry a 5 to 8%
Required rate of return = Real rate + Expected inflation+
Risk Premium
Risk Return Characteristics

Rate of Return Equity shares

Preference
Shares Risk
Coroporate
Premium
Bonds
Government
Rf Bonds
Real Rate of Return
T.Bills
Anticipated inflation

Risk
 Clients of the Financial system
 House hold Sector :
House hold financial decisions are concerned with how to invest money
constantly make decisions : work, Job training , Retirement planning, Savings vs
Consumption
Financial innovation vs Household

 The Business Sector :

How to raise money to finance their investments in real assets
Plants & equipments , technical know-how
Two ways for raise money:
i)Borrow from the banks or issuing Bonds to the public
ii) take new partners by issuing stocks
Investment banking industry to cater the business needs
Transforming simple securities into complex issues that suit particular
market niches.
 Clients of the Financial system
 The Government sector :
 Govt. often need to finance their expenditures by borrowings
 When tax revenues are not sufficient to cover expenditures
 Can also print currency ,this forced to increase inflation
 Because of taxing power makes them very creditworthy and therefore,
able to borrow at lower rates.
 A special role of the government is in regulating the financial
environment .
 The environment responds to clientele
demands
 Financial intermediation:
 Problem of households is how best to invest their funds
 Relative smallness of most households makes direct investment intrinsically difficult
 Financial intermediaries such as Banks, investment companies, insurance companies,
or credit unions Naturally evolve to bring to the two sectors together
 Sell own liabilities to raise funds that are used to purchase liabilities of other
corporation
 Lenders and borrowers do not need to contact each other directly
 Each goes to the bank, which act as an intermediary between them
 Profit opportunities alone dictate that banks will emerge in trading Economy
 These are distinguished from other businesses in that both their assets and liabilities
are overwhelmingly financial in nature
 To channel household savings to the business sector
 Significant diversification leads to risk mitigation :i) pooling ii) diversification iii)
expertise
 The profit opportunity through Mutual funds

FINANCIAL INTERMEDIATION
 Intermediary Market Role

Stock Exchange Capital Market Secondary Market to securities

Capital Market, Credit

Investment Bankers Corporate advisory services, Issue of securities
Market

Capital Market, Money

Underwriters Subscribe to unsubscribed portion of securities
Market

Issue securities to the investors on behalf of the

Registrars, Depositories, Custodians Capital Market
company and handle share transfer activity

Primary Dealers Satellite Dealers Money Market Market making in government securities

Forex Dealers Forex Market Ensure exchange ink currencies

 Investment Banking
 Special institutions which offer services like selling of securities like
stocks and bonds to the public on behalf of issuing company
 Services are able to provide a cost below that of running an in-house
security issuance division
 Ex: Merrill Lynch, Salomon Smith Barney, Goldman Sachs
 These are constantly in the market
 Maintain reputation and honesty
 Certification role- a ‘seal of approval’ to security issuers.
Market participants
 Top 10 investment Bankers
 May 2006 Source: Euromoney FX survey

Rank Name % of
Volume

1 Deutsche Bank 19.26

2 UBS AG 11.86
3 Citigroup 10.39
4 Barclays Capital 6.61
5 Royal Bank of Scotland 6.43

6 Goldman Sachs 5.25

7 HSBC 5.04
8 Bank of America 3.97
9 JPMorgan Chase 3.89
10 Merrill Lynch 3.68
Financial innovation and derivatives
 Investment diversity desired by households is far greater than most
businesses have a desire to satisfy
 Profit opportunity for innovative security design and repacking that
investment bankers are only happy to fill
 Mortgage pass through securities
 Collateralized mortgage obligation (CMO)
 Tranches , Fast pay tranches
 Primitive Vs Derivative securities
 Primitive security offers returns based only on the status of issuer
 Derivative securities yield returns depends on additional factors
pertaining to the prices of other assets
 Response to taxation and regulation
 Euro dollar market birth : dollar denominated time deposits in foreign
accounts.
 Regulation Q is not apply to these accounts
 Many USA banks and foreign competitors established branches in
london and other cities outside the USA
 Outside the banks could offer competitive rates outside the jurisdiction
of U.S. regulators
 Foreign branches exempt from reserve requirement leads to Euro
dollar
 Euro dollar market continue to thrive , thus complicating the lives of
U.S. monetary policy makers
 Deep discount and Zero coupon bonds
 Financial markets had discovered that zeros were useful ways to lock
in long-term investment return
 Investment, speculation and
 Gambling
Time and risk are two criteria that are sometimes used to differentiate
them
 Invesment :
interpreted by trustees
as long-term and low risk, usually restricted to government securities. Where
equities were concerned, these were to be
blue-chip companies,
bought for their future dividends.
 Speculation :
It is considered to be more short-term,
involving greater risk and
based on anticipating market movements
rather than judging the long-term
fundamentals of particular investment
Gambling :
It is considered to involve shortest waiting period , and the greater risk. But
here, too, the dividing line is sometimes difficult to draw
For ex: betting on the foot ball league championship
Ongoing trends

 Globalization:
*American Depository Receipts,
* purchase of foreign securities which offered in local
currency
* Invest Mutual funds that invest internationally
* Buy derivatives
* Common Currencies ( Euro-22 countries)
Securitization:
* Asset Back Securities
* Pass-throughs
* CMOs – Collateral Mortgage obligations
* CARs – Collateral Automobile Receipts
 Ongoing trends
 Financial Engineering
creation and design of securities with custom- tailored
characteristics, often regarding exposure to various source
of risk
* Boise Cascade Corporation with association of
Goldman Sachs and other underwriters – issued hybrid
security with features of preferred stock combined with
various call and put options
Features:
preferred stock for 4 years
converted into common stock
No. of shares depends on the price of the stock in 4 years
Ongoing trends
 Computer Networks :
* Internet (OLT, OLI)
* ERP ( SAP, Oracle, JD Edward)
* LAN, WAN
* Internet Investment Banking
* Online trading among investors
* On line sales of shares (Spring Street Brewing Company)
 Investment industry in Ethiopia
 Sectoral Distribution of Number , Capital of Approved projects in Ethiopia
 Sector No.of projects Capital share %
 Agriculture & forestry 369 6,043 20.58
 Construction 99 561 5.52
 Education 106 692 3.00
 Health and social work 61 828 3.40
 Hotels and restaurants 212 1,878 11.82
 Manufacturing 380 5,984 21.19
 Minining and Quarrying 1 1 0.06
 Community services 28 725 1.56
 Real estate 499 6,128 27.83
 Transport,communication 19 58 1.06
 Whole sale and retail 19 148 2.06
 Total 1793 23,050 100.0
 Source: Ethiopian Investment Agency
 Summary of Federal government Finance
 Particulars (million Birrs) 2007/08
 Total Revenue 31,022
 Tax Revenue 20,309
 Non-tax revenue 4,930
 grants & relief 5,783
 Total Expenditure 37,784
 Deficit -6762
 Total financing 6762
 Net external borrowings 2,287
 Net domestic borrowings 4,475
 Banking system: 4475
 Other sources : nil

 Source: Ministry of Finance and Economic Development

 Domestic Tax revenue (by major
components)
& expenditure
Direct tax revenue : 14%by component
(personal and Business
 Domestic Indirect taxes: 16%
 Foreign Trade taxes : 43%
 Non tax Revenue : 27% ( Dividends)
 Major components of Federal government Expenditure:
 Capital expenditure : 37%
 Current Expenditure : 23%
 Regional Transfers : 40%

Source: Ministry of Finance and Economic Development

 Size of the global fund management
industry
 2006 to reach a record $55.0 trillion. This was up 10% on the previous
year and 54% on 2002.
 Pension assets totalled $20.6 trillion in 2005,
 $16.6 trillion invested in insurance funds and $17.8 trillion in mutual
funds.
 Merrill Lynch also estimates the value of private wealth at $33.3 trillion
on conventional investment management.
 The US was by far the largest source of funds under management in
2005 with 48% of the world total
 It was followed by Japan with 11% and the UK with 7%.
 The Asia-Pacific region has shown the strongest growth in recent
years.
 Countries such as China and India offer huge potential and many
companies are showing an increased focus in this region
 10 largest asset management firms
 Global Investor’s 2005 top 10 asset managers by assets under (million USD)
 Rank management. Company Assets under
management Country
 1. Scottish Widows
Investment
Partnership 1,400,491 UK
 2. State Street
Global Advisors 1,367,269 US
 3.Fidelity
Investments 1,299,400 US
 4.Capital Group
 Companies 1,050,435 US
 5.Legg Mason
 891,400 US
 6.The Vanguard Group 852,000 US
 7.Allianz Global Investors 790,513 Germany
 8.JPMorgan Asset
 Management 782,646 US
 9.Bank of New York Mellon 738,294 US
 10.Deutsche Asset Management723,366 Germany
Variability
 The essentially feature of stock prices is
unpredictable variability
 Even when averaged into an index this
variability is apparent
 Portfolio management is about coping with the
variability
 Investment analysis is about underlying longer-
term trends
 The same principles apply to both
Variability
Variability
Variability
Variability
 Ethiopian Economy some indicators
 GDP at current market price ( Mn.Birr) : 170,921.4
 Real GDP growth Rate :11.4%
 Average Marginal Exchange rate ( Birr Per (USD)) : 9.62
 Agriculture & allied Activities (% of GDP) : 45.9
 Industrial Sector (% of GDP) : 13.3
 Service Sector (% of GDP) : 40.8
 GDP per capita :$255.4
 Gross Private Consumption (% of GDP) 83.8
 Gross Government Consumption ( % of GDP) 10.6
 Gross Domestic fixed investment ( % of GDP) 25.0
 Resource Balance (% of GDP) -19.4
 Minimum deposit rate : 4%
 Lending rate :7 to 14%
 No .of commercial Banks : 12 (3+9)
 No. of insurance companies : 10 (1+9)
 No. of Micro Financial Institutions : 28+1
 Several mechanisms to mitigate agency
problems
 Compensation plans to the managers ( stock options)
 BOD are sometimes portrayed as defenders of top management force
out management teams that are underperforming
 Outsiders such as Security analysts and large institutional investors
monitor firms closely
 Bad performers are subject to threat of takeover
Domestic Economic Environment
Proposed Budget -2008/09

 Federal Budget will be 54.3 Bln

( Sufian Ahmed – MoFED)
 Which exceed by 21 % compare to current budget
 The allocation for capital projects is likely to be 23.4 Bln
 Subsidies to regional states will increase to 16.5 Bln
 Federal agencies that would benefit the most from next year’s budget will
be
 The Ethiopian Roads Authority (ERA)- 7.7 Bln ETBs (10 Bln ETBs)
 (Director – general – Zaid Woldegebriel )
 The Ministry of Defense ( MOD) – 4 Bln ETBs
 The Ministry of Education ( MOE) – 2.2 Bln ETBs ( 9 Bln ETBs
requested – the current allotment is 3.2 Bln ETBs)
 Domestic Borrowings – 4.8 Bln ETBs ( 2% of GDP)
Talks of Thriving Industry
 Industry Sector
 ( Manufacturing, Construction, Power development)
 Target set Five year Plan 2005/06 to 2009/10 will be 9% annual
average growth
 First and second year of the program the industry grew by 10.2 and
11% respectively
 The current fiscal year the expected growth rate of sector by 12%
 Manufacturing :
 Target set – 10%
 First and second year grew by 13.7 and 12.6 respectively
 The current fiscal year expected growth rate is 12%
 Note : Manufacturing sector is the second fastest growing sector
after service sector
Priority industry Sectors and their status
in Ethiopia
 The leather and leather articles
Bring substantial amount of foreign currency by providing value
added products
The country plan to produce 60,000 to 70,000 pairs of shoes a day
by end of 2010 ( present capacity is 24,000 pairs )
The plan to export 25 mln shoes by the end of 5 year development
strategy
Export of leather and leather products , ethiopia expects 221 Million
ETBs annual proceeds in 2010


Textile and Garment sector

Foreign Currency earnings from sector to 500 million $ by 2011

 191 investment projects should be implemented
 The Govt is privatizing state owned textile garment factories
DIRE DAWA, AWASSA,ARBA MINCH AND MODJO textile factories have
been privatized on lease basis
EDIGET have been sold ,
KOMBOLCHA, BAHIRDAR and ADEY ABABA are still under state ownership
New textile and garment factories are being built in
ALEMGENA, ADAMA and Addis Ababa
Regional state of OROMIA in ALEMGENA New textile factory – AYKA ADDIS –
which is expected to complete 2008/09
Expansion of MAA garment , - A subsidiary company of MIDROC ETHIOPIA
Investors from TURKEY and Asian continent countries are keen interest to invest
in this sector
Horticulture
 Government plan to cover 2000 hectares of land with green house
required for flower production by 2010
 The govt has prepared 700 hectares of land in BAHIR DAR
 There are65 flower exporters and half of them are foreigners
 The govt plan to cover 3000 hectares of land with fruits and
vegetables. So far 974 hectares of land have been covered by
green house
 BGI Ethiopia has Acquired 450 hectares of land suitable for vine
production
 The govt is trying to privatize the upper AWASH state owned farm
 Ethiopian flower exports is reaching to over 60 countries even in
these ethiopia does not have diplomatic representation
Cement industry
The current capacity of production -1.6 million tonnes per year
22 investment projects have been licensed
3 already started production
New plants produced 3.2 M.T per year
End of 2010 Annual production of cement will be 10 M.T
DERBA MIDROC – 1st in Ethiopia
Ture Cement factory- 2nd in ethiopia
Ascon – Egypt company ( A geology, mining manufacturing company)
Factories :
MUGHER, ARBA MINCH, ETHIO CEMENT, DIRE DAWA NATIONAL
CEMNT FACTORIES
Problems :
shortage of Power, Roads , Telecom, and carrying capacities of bridges to
transport heavy machines meant for cement factories
“ Construction of The condominiums “ across the country is a flag ship project
of federal government
Sugar industry
 Annual capacity from 300,000 to 1.5 mtns
 Plan to 143 M.litres of Ethnol from molasses- the bio-
product of sugar
 Nile petroleum Ltd – the company which blends ethanol
with benzene at its depots located in SULULTA , 25 kms
north of the capital in the Oromia Regional state
 Govt also assiting to Chemical, Pharmaceuticals and
Steel industries