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Investment Selected CH 1
Investment Selected CH 1
(2013 E.C.)
CHAPTER: ONE.
1. Introduction to investment.
What is Investment?
Investment is the commitment of money or capital to purchase financial instruments or other
assets in order to gain profitable returns in the form of interest, income, or appreciation of the
value of the instrument. Investment is related to saving or deferring consumption.
Meaning of Investment:
An investment involves the choice by an individual or an organization such as a pension fund,
after some analysis or thought, to place or lend money in a vehicle, instrument or asset, such as
property, commodity, stock, bond, financial derivatives (e.g. futures or options), or the foreign
asset denominated in foreign currency, that has certain level of risk and provides the possibility
of generating returns over a period of time.
When an asset is bought or a given amount of money is invested in the bank, there is anticipation
that some return will be received from the investment in the future.
Definition of Investment from different Perspectives:
Investment is a term frequently used in the fields of economics, business management and
finance. It can mean savings alone, or savings made through delayed consumption. Investment
can be divided into different types according to various theories and principles.
While dealing with the various options of investment, the defining terms of investment need to
be kept in mind.
Investment in terms of Economics:
According to economic theories, investment is defined as the per-unit production of
goods, which have not been consumed, but will however, be used for the purpose of
future production.
Examples of this type of investment are tangible goods like construction of a factory or
bridge and intangible goods like 6 months of on-the-job training.
In terms of national production and income, Gross Domestic Product (GDP) has an
essential constituent, known as gross investment.
Investment in terms of Business Management:
According to business management theories, investment refers to tangible assets like
machinery and equipments and buildings and intangible assets like copyrights or patents
and goodwill. The decision for investment is also known as capital budgeting decision,
which is regarded as one of the key decisions.
Investment in terms of Finance:
In finance, investment refers to the purchasing of securities or other financial assets from
the capital market. It also means buying money market or real properties with high
market liquidity. Some examples are gold, silver, real properties, and precious items.
Financial investments are in stocks, bonds, and other types of security investments.
Indirect financial investments can also be done with the help of mediators or third parties,
such as pension funds, mutual funds, commercial banks, and insurance companies.
Investment in terms of Personal Finance:
According to personal finance theories, an investment is the implementation of money
for buying shares, mutual funds or assets with capital risk.
Bank savings.
Savings accounts with major banks are one of the most common and least risky ways to store
your money for the short term. Credit unions and building societies also offer savings accounts.
When you deposit money in an account you are lending it to the bank, which pays you some
interest in return. The interest you can earn is relatively low, so savings accounts are not the best
option if you are looking for long-term growth.
Term deposits.
Like savings accounts, term deposits also pay interest. The difference is that you agree to lend
your money to the bank for a fixed period of time such as 6 or 12 months in return for a higher
rate of interest.
Bonds.
Investments are often called assets and different kinds of investments such as bonds and shares
are called asset classes.
A bond may be issued by a government, council, or company. You lend them your money for a
number of years, and they promise to pay a certain interest rate – called a coupon.
A bond offering invites them to make a loan in exchange for the promise of repayment in full
plus a certain rate of interest for the use of the money.
The level of risk involved when investing in bonds depends on the issuer. Unlike term deposits,
you can sell your bonds early. However the price you will get can go up and down. Bonds are
also sometimes called fixed interest investments.
Shares.
When you buy a share, you’re buying a small part of a company. A stock offering invites
investors to buy an ownership position in the company. If that company makes money, you may
be paid a share of the profit, called a dividend. Like house prices, share prices are generally
expected to go up over time and give you a ‘capital gain’ on your money when you sell.
However, prices can fall in value as well.
Property.
Returns from investing in property come from rental income and from any increase in the value
of property over time – called capital gain. Some people view their own home as an investment
because it may grow in value. It doesn’t have the income that letting property to other
individuals or businesses brings. You can invest in commercial property directly, or through
managed funds.
Most investors should have a mix of investments to smooth out the ups and downs.
When you buy units in a managed fund you are spreading your savings across a range of shares
or other investments within the fund. That means that your money is 'diversified’.
If you are a member of a Kiwi-Saver scheme you are already investing in a type of managed
fund.
Professional investors still use derivatives for this purpose, but can now also use them to invest
more efficiently.
Other alternatives.
Other alternatives can include things such as private equity, hedge funds, fine wine, exotic cars
and stamps. There are different reasons for buying each one, but, as with all investments, their
value can go up or down. https://www.sorted.org.nz/a-z-guides/kinds-investments
They may be a corporation or trust engaged in the business of investing the pooled capital of
investors in financial securities. This is most often done either through a closed-end fund or an
JJU, COBE, Dep’t of ACFN, Compiled by Instructor;-
Page-- 4.
“Mahamedkeder Abdilahi Yusuf”.
Chapter-One, Investment Analysis and Portfolio Management (ACFN 3201), Jig-Jiga University. June, 2021.
(2013 E.C.)
open-end fund (also referred to as a mutual fund). In the U.S., most investment companies are
registered with and regulated by the Securities & Exchange Commission under the Investment
Company Act of 1940. Also known as "fund company" or "fund sponsor".
An investment company invests the money it receives from investors on a collective basis, and
each investor shares in the profits and losses in proportion to the investor's interest in the
investment company. The performance of the investment company will be based on (but it won't
be identical to) the performance of the securities and other assets that the investment company
owns.
The federal securities laws categorize investment companies into three basic types:
Each type has its own unique features. For example, mutual fund and UIT shares are
"redeemable" (meaning that when investors want to sell their shares, they sell them back to the
fund or trust, or to a broker acting for the fund or trust, at their approximate net asset value).
Closed-end fund shares, on the other hand, generally are not redeemable. Instead, when closed-
end fund investors want to sell their shares, they generally sell them to other investors on the
secondary market, at a price determined by the market. In addition, there are variations within
each type of investment company, such as stock funds, bond funds, money market funds, index
funds, interval funds, and exchange-traded funds (ETFs).
Some types of companies that might initially appear to be investment companies may actually be
excluded under the federal securities laws. For example, private investment funds with no more
than 100 investors and private investment funds whose investors each have a substantial amount
of investment assets are not considered to be investment companies—even though they issue
securities and are primarily engaged in the business of investing in securities. This may be
because of the private nature of their offerings or the financial means and sophistication of their
investors. For additional information on these types of private investment funds, please refer to
Hedge Funds in our Fast Answers databank.
Before purchasing shares of an investment company, you should carefully read all of a fund's
available information, including its prospectus and most recent shareholder report.
Investment companies are regulated primarily under the Investment Company Act of 1940 and
the rules and registration forms adopted under that Act. Investment companies are also subject to
the Securities Act of 1933 and the Securities Exchange Act of 1934. For the definition of
"investment company," you should refer to Section 3 of the Investment Company Act of 1940
and the rules under that section.http://www.sec.gov/answers/mfinvco.htm
Investment companies will generally agree that new investors should focus on building a
financial foundation before exploring more complex and risky investments, so look for an
investment company that will have your best interests (not just the company's) in mind.
http://www.consumeraffairs.com/finance/invest.html
For example, the issuer of a bond issue may be a municipal government raising funds for a
particular project. Investors of securities may be retail investors - those who buy and sell
securities on their own behalf and not for an organization - and wholesale investors - financial
institutions acting on behalf of clients or acting on their own account. Institutional investors
include investment banks, pension funds, managed funds and insurance companies.
Securities are typically divided into debt securities and equities. A debt security is a type of
security that represents money that is borrowed that must be repaid, with terms that define the
amount borrowed, interest rate and maturity/renewal date. Debt securities include government
and corporate bonds, certificates of deposit (CDs), preferred stock and collateralized securities
(such as Collateralized debt obligations ”CDOs” and collateralized mortgage obligation
“CMOs”).
Securities markets can be split into two levels. Primary markets, where new securities are issued
and secondary markets where existing securities can be bought and sold. Secondary markets can
There are a number of professional participants of a securities market and these include;
brokerages, broker-dealers, market makers, investment managers, speculators as well as those
providing the infrastructure, such as clearing houses and securities depositories.
A securities market is used in an economy to attract new capital, transfer real assets in financial
assets, determine price which will balance demand and supply and provide a means to invest
money both short and long term.
This is the market for new long term equity capital. The primary market is the market
where the securities are sold for the first time. Therefore it is also called the new issue
market (NIM).
In a primary issue, the securities are issued by the company directly to investors.
The company receives the money and issues new security certificates to the investors.
Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business.
The primary market performs the crucial function of facilitating capital formation in the
economy.
The new issue market does not include certain other sources of new long term external
finance, such as loans from financial institutions. Borrowers in the new issue market may
be raising capital for converting private capital into public capital; this is known as
"going public."
ii. Secondary market.
The secondary market, also known as the aftermarket, is the financial market where previously
issued securities and financial instruments such as stock, bonds, options, and futures are bought
and sold. The term "secondary market" is also used to refer to the market for any used goods or
assets, or an alternative use for an existing product or asset where the customer base is the
second market (for example, corn has been traditionally used primarily for food production and
With primary issuances of securities or financial instruments, or the primary market, investors
purchase these securities directly from issuers such as corporations issuing shares in an IPO or
private placement, or directly from the federal government in the case of treasuries. After the
initial issuance, investors can purchase from other investors in the secondary market.
The secondary market for a variety of assets can vary from loans to stocks, from fragmented to
centralized, and from illiquid to very liquid. The major stock exchanges are the most visible
example of liquid secondary markets - in this case, for stocks of publicly traded companies.
Exchanges such as the New York Stock Exchange, Nasdaq and the American Stock Exchange
provide a centralized, liquid secondary market for the investors who own stocks that trade on
those exchanges. Most bonds and structured products trade “over the counter,” or by phoning the
bond desk of one’s broker-dealer. Loans sometimes trade online using a Loan Exchange.
Over-the-counter market.
Over-the-counter (OTC) or off-exchange trading is to trade financial instruments such as
stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with
exchange trading, which occurs via facilities constructed for the purpose of trading (i.e.,
exchanges), such as futures exchanges or stock exchanges. In the U.S., over-the-counter trading
in stock is carried out by market makers that make markets in OTCBB and Pink Sheets securities
using inter-dealer quotation services such as Pink Quote (operated by Pink OTC Markets) and
the OTC Bulletin Board (OTCBB). OTC stocks are not usually listed nor traded on any stock
exchanges, though exchange listed stocks can be traded OTC on the third market. Although
stocks quoted on the OTCBB must comply with United States Securities and Exchange
Commission (SEC) reporting requirements, other OTC stocks, such as those stocks categorized
as Pink Sheets securities, have no reporting requirements, while those stocks categorized as
OTCQX have met alternative disclosure guidelines through Pink OTC Markets. An over-the-
counter contract is a bilateral contract in which two parties agree on how a particular trade or
agreement is to be settled in the future. It is usually from an investment bank to its clients
directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the
computer or the telephone. For derivatives, these agreements are usually governed by an
International Swaps and Derivatives Association agreement.
This segment of the OTC market is occasionally referred to as the "Fourth Market."
The New York Mercantile Exchange (NYMEX) has created a clearing mechanism for a slate of
commonly traded OTC energy derivatives which allows counterparties of many bilateral OTC
transactions to mutually agree to transfer the trade to Clear Port, the exchange's clearing house,
thus eliminating credit and performance risk of the initial OTC transaction counterparts.