Concept of Investment

‡ Investing in various types of assets is an interesting activity

that attracts people from all walks of life irrespective of their
occupation, economic status, education and family
background.
‡ When a person has more money than he requires for current
consumption, he would be coined as a potential investor.
The investor who is having extra cash could invest it in
securities or in any other assets like or gold or real estate or
could simply deposit it in his bank account
‡ The companies that have extra income may like to invest
their money in the extension of the existing firm or
undertake new venture. All of these activities in a broader
sense mean investment.
mow do you Define Investment?
‡ We can define investment as the process of,
´sacrificing something now for the prospect
of gaining something laterµ. So, the definition
implies that we have three dimensions to an
investment-time, today·s sacrifice and
prospective gain.
 mow is Investment Different from
Speculation?
‡ We know that investment means sacrificing or
committing some money today in anticipation of a
financial return later. The investor indulges in a bit
of speculation involved in all investment decisions.
It does not follow through that all investments are
all speculative by nature.
 mow is Investment Different from
Speculation?
‡ Genuine investments are carefully thought out
decisions. They involve only calculated risks. The
expected return is consistent with the underlying
risk of the investment. A genuine investor is risk
averse and usually has a long-term prospective in
mind. The government officer·s investment in the
units of UTI , the college professor·s Reliance
stockholding , the lady clerk·s Post Office Savings
Deposit, all may be regarded as genuine
investments. Each person seems to have made
carefully thought out decision and each has only
calculated risk.
mow is Investment Different from
Speculation?
‡ Speculative investments on the other hand
are not carefully thought out decisions. They
are based on rumours, hot tips, inside dopes
and often simply on hunches. The risk
assumed is disproportionate to the return
expected from speculation. The intention is
to profit from short-term market fluctuations.
In other words, a speculator is relatively less
risk averse and has a short-term perspective
for investment.
 Gambling
‡ Gambling is defined in webster·s dictionary as ¶ An
act of betting on uncertain outcome.
‡ In gambling the outcome is largely a matter of luck,
no rational economic reason can be given for it.
‡ Unlike investors and speculator, the gamblers are
risk lovers in the sense that the risk they assume is
quite disproportionate to the expected reward.
 Does the Investment Suffer from any
Constraints!
‡ Liquidity
‡ Age
‡ Need for regular income
‡ Risk Tolerance
‡ Tax liability
‡ Time morizon
 Classification of various investment
alternatives.
‡ Type 1 investments have the lowest investment risk
with relatively low returns. These include savings
accounts, post office certificates of deposit, bonds,
treasury securities, and government agency
securities.
‡ Type 2 investment have the highest investment risk
with the highest return. This include investment in
stock market directly or indirectly.
 Investment Objectives
‡ Near-term migh Priority Goals
‡ Long-term migh Priority goals
‡ Low Priority Goals
‡ Entrepreneurial or Money Making Goals
 Near-term migh Priority Goals

‡ These are goals which have a high emotional

priority to the investor and he wishes to achieve
these goals within a few years. As a result
investment vehicles for these goals tends to be in
the form of fixed-income instruments with maturity
dates correspondence with the goal dates. Because
of the high emotional importance these goals have,
investor, especially the one with moderate means
will not go for any other form of investment which
involves more risk especially where his goal is just
in sight.
Long-term migh Priority goals
‡ For most people, this goal is an indication of
their need at a point some years ahead in the
future. Eg. Financial independence at the
time of retirement or starting a fund for
higher education of a three year old child.
Because of long term nature of such goals
there is not a tendency to adopt more
aggressive approach. Preferred by the people
of moderate means.
Low priority Goals
‡ This goals are much lower down in the scale
of priority and are not particularly painful if
not achieved. For people with moderate to
substantial wealth, this could range from a
world tour to donating funds for charity. As a
result, investors often invest in speculative
kinds of investment either for fun or just to
try out some particular aspect of the
investment process.
Entrepreneurial or Money Making
Goals
‡ This goal pertain to individual who want to
maximize wealth not satisfied by the
conventional saving and investment
approach. These investor usually put all the
spare money they have into stocks preferably
of the company in which they are
working/owing and leave it there until it
reaches some level which either the
individual believes is enough or is scared of
losing what has been built up over the years.
Investment Risk
‡ Systematic Risk
‡ Unsystematic Risk
Unsystematic Risk
‡ Is firm-specific risk that is unique to a
security and hence can be eliminated by
forming diversified portfolios.
‡ Risk that is uncorrelated to the
overall market risk. In other words,
the risk that is firm-specific and can be
diversified through holding
a portfolio of stocks.
‡ This is also called business risk.
Systematic Risk
‡ he portion of an investment's risk that is
coincident with the market and thus cannot
be eliminated by diversification. Measured by
the security's beta coefficient. Also called
market risk.
‡ This type of risk affects a broad range of
securities.
 Risk Classification
‡ Interest Risk
‡ Reinvestment Risk
‡ Default Risk
‡ Inflation Rate Risk
‡ Business risk
‡ Financial risk
‡ Liquidity risk
‡ Exchange rate risk
‡ Country risk
 Interest Risk
‡ The possibility of a reduction in the value of a security,
especially a bond, resulting from a rise in interest rates.
‡ Investment risk associated with the possibility that there is a
rise in the interest rates after a fixed income security has
been purchased resulting in a decline in that security's
price. The longer the maturity date of that security, the
greater the exposure of the security's price to interest rate
fluctuations.
‡ Risk that an interest-earning asset, such as a bank loan, will
decline in value as interest rates change. Longer maturity,
fixed rate loans are more sensitive to price risk from
changes in rates than variable rate loans.
Reinvestment Risk
‡ A falling interest rate periods, the investors
cannot reinvest at the same interest rates at
which the earlier income were reinvested.
Default Risk
‡ It is the risk which arises when the issuer is
not able to satisfy the terms and conditions
of the obligation with respect to the timely
payment of interest and repayment of the
amount borrowed.
‡ Default risk has a significant effect on the
value of a bond: if a borrower's ability to
repay debt is impaired, default risk is higher
and the value of the bond will decline.
Inflation Rate Risk
‡ The possibility that
the value of assets or income will decrease
as inflation shrinks the purchasing power of
a currency. Inflation causes money to
decrease in value at some rate, and does so
whether the money is invested or not.
Business Risk

‡ Business risk arises due to:

² Uncertainty of income flows caused by the
nature of a firm·s business
² Sales volatility and operating leverage determine
the level of business risk.
Financial Risk

‡ Financial risk arises due to:

² Uncertainty caused by the use of debt financing.
² Borrowing requires fixed payments which must
be paid ahead of payments to stockholders.
² The use of debt increases uncertainty of
stockholder income and causes an increase in
the stock·s risk premium.
Liquidity Risk
‡ Liquidity risk arises due to the uncertainty
introduced by the secondary market for an
investment.
² mow long will it take to convert an investment into
cash?
² mow certain is the price that will be received?
Exchange Rate Risk
‡ Exchange rate risk arises due to the
uncertainty introduced by acquiring
securities denominated in a currency different
from that of the investor.
‡ Changes in exchange rates affect the
investors return when converting an
investment back into the ´homeµ currency.
Country Risk
‡ Country risk (also called political risk) refers
to the uncertainty of returns caused by the
possibility of a major change in the political or
economic environment in a country.
‡ Individuals who invest in countries that have
unstable political-economic systems must
include a country risk-premium when
determining their required rate of return
 Mutual Funds
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Advantages of Mutual Funds
‡ Reduced Risk
‡ Diversified Investment
‡ Tax Benefits


  
 





‡ Sponsor: The Sponsor of a fund is the entity
that sets up the mutual fund.
‡ Board of Trustees: The fund is governed
either by a Board of Trustees, or The
Directors Of A Trustees Company. The
sponsor selects them. The Board of Trustee
is responsible for protecting the investors·
interests.
‡ Asset Management Company (AMC)
‡ Custodian
Mutual Fund Trust
‡ Planning and formulation of mutual fund
schemes.
‡ Seeking SEBI·s approval and authorizations
to these schemes.
‡ Marketing the scheme
Role of AMCs
‡ Taking investment decision and making
investments of funds through broker in the
secondary market or directly in the primary
market or money market instruments
‡ Realize fund position by taking accounts of
all receivable and realizations
‡ Maintaining proper accounting and
information for pricing the units
 Role of Custodian
‡ Safe Custody
‡ Trade Settlement
‡ Corporate Action
‡ Transfer Agent
Organizational Set Up of Mutual
Fund
 Net Asset Value(NAV)
‡ It is the actual value of the investments made by the
mutual fund for each unit issued by it.
‡ It changes almost on a daily basis as the market
prices of individual securities in its portfolio
fluctuate
‡ As the intrinsic value of the security represent the
fair value of the security, the NAV represents the
fair value of a unit in a mutual fund
Functional Classification of
Mutual Funds
‡ Open Ended Mutual Fund
‡ Close Ended Mutual Fund
Open Ended Mutual Fund
‡ Units of mutual funds can be bought/sold
throughout the life of the mutual fund
scheme
‡ Units of mutual fund are bought/sold at NAV
Closed Ended Mutual Funds
‡ Closed ended mutual fund investment
company has a definite target amount for the
funds, and can not sell more units after its
initial offering
‡ Units of closed ended mutual funds are not
redeemable at their NAV
 Portfolio Classification of Mutual
Funds
‡ Bond Funds
‡ Stock Funds
‡ Money Market Funds
‡ Growth Funds
‡ Balanced Funds
Geographical Classification of
Mutual Funds
‡ Domestic Mutual Funds
‡ Offshore Mutual Funds