Unit 1

In finance
In finance, investment is the commitment of funds by buying securities or other monetary or
paper (financial) assets in the money markets or capital markets, or in fairly liquid real assets,
such as gold or collectibles. Valuation is the method for assessing whether a potential investment
is worth its price. Returns on investments will follow the risk-return spectrum.

Types of financial investments include shares, other equity investment, and bonds (including
bonds denominated in foreign currencies). These financial assets are then expected to provide
income or positive future cash flows, and may increase or decrease in value giving the investor
capital gains or losses.

In economics or macroeconomics
In economic theory or in macroeconomics, investment is the amount purchased per unit time of
goods which are not consumed but are to be used for future production. Examples include
railroad or factory construction. Investment in human capital includes costs of additional
schooling or on-the-job training. Inventory investment refers to the accumulation of goods
inventories; it can be positive or negative, and it can be intended or unintended. In measures of
national income and output, gross investment (represented by the variable I) is also a
component of Gross domestic product (GDP), given in the formula GDP = C + I + G + NX,
where C is consumption, G is government spending, and NX is net exports. Thus investment is
everything that remains of total expenditure after consumption, government spending, and net
exports are subtracted (i.e. I = GDP - C - G - NX).

Non-residential fixed investment (such as new factories) and residential investment (new houses)
combine with inventory investment to make up I. Net investment deducts depreciation from
gross investment. Net fixed investment is the value of the net increase in the capital stock per
year.

Fixed investment, as expenditure over a period of time ("per year"), is not capital. The time
dimension of investment makes it a flow. By contrast, capital is a stock— that is, accumulated
net investment to a point in time (such as December 31).

Investment is often modeled as a function of Income and Interest rates, given by the relation I =
f(Y, r). An increase in income encourages higher investment, whereas a higher interest rate may
discourage investment as it becomes more costly to borrow money. Even if a firm chooses to use
its own funds in an investment, the interest rate represents an opportunity cost of investing those
funds rather than lending out that amount of money for interest.[5]
Investment objective.
An investment objective is a financial goal that helps determine the type of investments you
make. For example, if you want a source of regular income, you might select a portfolio of high-
rated bonds and dividend-paying stocks.

Each mutual fund describes its investment objective in its prospectus, along with the strategy the
fund manager follows to meet that objective. Mutual fund investors often look for funds whose
stated objectives are compatible with their own goals.

Characteristics of Investments
It is worthwhile considering the characteristics of some forms of investment popular amongst
individuals. The most popular is probably the bank or building society deposit. On the upside
these arefree of capital risk, offer an income yield, and are usually liquid. On the downside they
lack substantialgrowth potential, are subject to a high level of income risk and have inflation
risk.Rental, or buy-to-let, property has become popular in recent years. Such investment has
growthpotential and provides an income yield. On the downside it is illiquid and subject to both
income andcapital risk. The income risk relates to the possibility that rents fall, or that a property
fails to attracttenants and remains unoccupied for long periods. The capital risk exists because
property prices canfall.A third investment alternative is provided by equity unit trusts, which
invest in a broad portfolio ofshares. These provide growth potential and are liquid. On the
downside they are prone to both capitaland income risk. The income risk is such that no income
yield may be forthcoming during someperiods.A related investment possibility is provided by
high-income equity unit trusts. These differ from otherequity unit trusts in persistently providing
an income yield, and probably with less income risk.A higher current level of income is normally
available from bond unit trusts. These are liquid withrelatively low levels of income and capital
risk. However they do not usually offer much growthpotential and are vulnerable to inflation
risk.

Investment & Investing

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 trade offs. 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.

Types of Investments
The various types of investment are:

 Cash investments

: These include savings bank accounts, certificates of deposit (CDs) and treasury bills. These
investments pay a low rate of interest and are risky options in periods of inflation.

 Debt securities: This form of investment provides returns in the form of fixed periodic payments
and possible capital appreciation at maturity. It is a safer and more 'risk-free' investment tool
than equities. However, the returns are also generally lower than other securities.

 Stocks: Buying stocks (also called equities) makes you a part-owner of the business and entitles
you to a share of the profits generated by the company. Stocks are more volatile and riskier than
bonds.

 Mutual funds: This is a collection of stocks and bonds and involves paying a professional manager
to select specific securities for you. The prime advantage of this investment is that you do not
have to bother with tracking the investment. There may be bond, stock- or index-based mutual
funds.

 Derivatives: These are financial contracts the values of which are derived from the value of the
underlying assets, such as equities, commodities and bonds, on which they are
based. Derivatives can be in the form of futures, options and swaps. Derivatives are
used to minimize the risk of loss resulting from fluctuations in the value of the underlying assets
(hedging).

 Commodities: The items that are traded on the commodities market are agricultural and
industrial commodities. These items need to be standardized and must be in a basic, raw and
unprocessed state. The trading of commodities is associated with high risk and high reward.
Trading in commodity futures requires specialized knowledge and in-depth analysis.
  Real estate: This investment involves a long-term commitment of funds and gains that are
generated through rental or lease income as well as capital appreciation. This includes
investments into residential or commercial properties.

An alternative investment is an investment product other than the traditional investments of

stocks, bonds, cash or property. The term is a relatively loose one and includes tangible assets
such as Art, Wine, Antiques, Coins or Stamps[1] and some financial assets such as commodities,
private equity, hedge funds and financial derivatives.

Characteristics
Alternative investments are sometimes used as a tool to reduce overall investment risk through
diversification.

Some of the characteristics of alternative investments may include:

 Low correlation with traditional financial investments such as stocks and shares.
 Alternative investments may be relatively illiquid.
 It may be difficult to determine the current market value of the asset.
 There may be limited historical risk and return data.
 A high degree of investment analysis may be required before buying.
 Costs of purchase and sale may be relatively high.

Investment Choices

The investment choices available to you through Savings Plus fall into three major asset classes:
stocks, bonds, and short-term investments.

“Stocks” can be further broken down into large-cap stock, mid-cap stock, small-cap stock, and
international stock.

Savings Plus also offers a specialty fund, the socially responsible fund.

An important approach to consider is to spread your investments across asset classes — a

technique known as diversification or asset allocation. Doing so can help you increase your total
return according to the level of risk you’re willing to accept. Diversification alone does not
assure a profit or protect against loss in a declining market.

The simplest way to achieve asset allocation for your Savings Plus investments is to invest in a
Savings Plus Asset Allocation Fund.

The following links provide more information:

 1. More about Asset Classes
2. Getting to Know Stock Funds
3. Investment Style

Three steps are involved in the evaluation of an investment:

• Estimation of cash flows

• Estimation of the required rate of return (the cast of capital)
• Application of a decision rule for decision rule for making the choice

Investment decision rule

The investment decision rules may be referred to as capital budgeting techniques, or investment
criteria. A sound appraisal technique should be used to measure the economic worth of an
investment project. The essential property of a sound technique is that is should maximize the
shareholders wealth. The following other characteristics should also be possessed by a sound
investment evaluation criterion:

• It should consider all cash flows to determine the true profitability of then project.
• It should provide for an objective and unambiguous way of separate good projects from bad
projects.
• It should help ranking of projects according to their true profitability.
• It should recognize the fact that bigger cash flows are preferable to smaller ones and early cash
flows are preferable to later ones.
• It should help to choose among mutually exclusive projects that project which maximizes the
shareholders wealth.
• It should be a criterion which is applicable to any conceivable investment project independent
of others.

These conditions will be clarified as we discuss the features of various investment criteria in the
following posts.
Investment Appraisal Criteria

A number of investment appraisal criteria or capital budgeting techniques are in use of practice.
They may be grouped in the following two categories:

1. Discounted cash flow criteria

• Net present value
• Internal rate of return
• Profitability index (PI)

2. Not discounted cash flow criteria

• Payback period
• Accounting rate of return
• Discounted payback period

Discounted payback is a variation of the payback method. It involves discounted method, but it
is not a true measure of investment profitability. We will show in our following posts the net
present value criterion is the most valid technique of evaluating an investment project. It is
consistent with the objective of maximizing the shareholders wealth.

The Concepts of Return on Investment & Risk

By Stan Aberdeen, eHow Contributor

updated: September 15, 2009

Investment return and risk are fundamental to understanding market behavior. Return on
investment is essentially profit made by an investor. Profits and losses must be analyzed
carefully, as simple percentage comparisons give misleading answers. Risk refers to the
probability of depreciation as well as its potential magnitude, which can exceed original invested
amount. Risk and return on investment are directly correlated; higher risk begets a smaller
chance of high return and vice versa.

Return on Investment (ROI)

1. The term refers to how much money is gained or lost after an investment. If you invest $1,000
and get back $1,080, you have an $80 (8 percent) return on the investment.

A negative return looks like this: You invest $1,000 and a year later only $900 remains. Return in
this case was negative $100, or negative 10 percent. The percentage is in relation to original
amount invested.

Unbalanced Percentages
 2. Gains and losses do not balance out with percentages. For example, $1,000 invested has a -10
percent annual return. So a year later, $1,000 is reduced to $900. Now, if that $900 had a 10
percent positive annual return the year after that, 10 pecent of $900 is $90. Therefore, the total
after two years is $990, less than the starting $1,000. The numbers work slightly against the
investor even though percentages even out.

Risk: Depreciation Probability

3. Risk is a comprehensive term. It encompasses probability and magnitude of a loss. Buying stock
allows a possibility that amount invested disappears from your account as the company goes
out of business. That is bigger risk than buying a well-rated bond in terms of depreciation
probability. A well-rated bond is less likely to give negative return on investment than stocks.
Therefore, as a general rule, stocks have a higher depreciation probability.

Risk: Depreciation Magnitude

4. Risk increases if loss exceeds amount invested even if loss probability remains unchanged.
Consider short-selling. The likelihood of stock ABC decreasing in value remains the same
regardless of buying equity or short-selling. If $1,000 worth of ABC stock doubles in value, a
short-seller has to pay $2,000, which is a negative 100 percent ROI. But if ABC stock triples in
value, you have to pay $3,000, realizing a negative 200 percent ROI. Magnitude of possible loss
is crucial in quantifying risk.

High Risk and Return

5. Higher risk corresponds to higher returns. Let's examine what influences bond interest rate. If
the seller has a record of success, people will feel comfortable giving the seller money for a
promised return later. The seller knows this, and therefore can offer a low rate. A buyer may
feel safe and therefore purchase the debt, or not if they decide that the low return isn't worth
having their money tied up with the issuer for years.

Low Risk and Return

6. By contrast, if the bond issuer has a questionable reliability record, it will take promise of a
larger return (a "junk bond") to entice investors. A buyer may be greedy for the possibility of
high returns and purchase the bond or decline by deciding the potential payoff isn't worth the
possibility of losing some, if not all, of the original invested amount.

Read more: The Concepts of Return on Investment & Risk | eHow.com

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