I n v e s t m e n t M a n a g e m e n t1
Module-1
Nature and scope of investment management-financial and economic- meaning of investment.
Importance of investments - factors favorable for investments-investment media- features of
investment programme – risk - different types of risk
Investment Management
The income that a person receives may be used for purchasing goods and services that he
currently requires or it may be saved for purchasing goods and services that he may require in the
future. The person saving a part of his income tries to find a temporary repository for his savings
until they are required to finance his future expenditure. This result in 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..
Meaning of investment
Generally, investment is the application of money for earning more money. The term
‘investing” could be associated with the different activities, but the common target in these
activities is to “employ” (use) the money during the time period seeking to enhance / increase
the investor’s wealth. Funds to be invested come from assets already owned, borrowed money
and savings.
Investment is an activity which is different from saving. Saving money means keeping aside
a part of your income in order to deal with unexpected expenses. Investment means putting your
saved money in various products in order to earn returns and increase wealth. If one person has
advanced some money to another, he may consider his loan as an investment. He expects to get
back the money along with interest at a future date. Another person may have purchased one
kilogram of gold for the purpose of price appreciation (increase) and may consider it as an
investment.
In all these cases it can be seen that investment involves employment of funds with the
main aim of achieving additional income or growth in the values.
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Definition
Investment may be defined as “a commitment of funds made in the expectation of some positive
rate of return “.
According to sharpe, ”investment is sacrifice of certain present value for some uncertain future
values”.
Objectives / Characteristics / Features of investment
The main objective of an investment process is to minimise risk while simultaneously maximising
the expected returns from the investment and assuring safety and liquidity of the invested assets.
Investors desire to earn as large returns as possible but with the minimum of risk. Risk can be
stated as the probability that the actual return realised from an investment may be different from
the expected return. Government securities constitute the low risk category as there is very little
deviation from expectations and hence are riskless. Shares of companies would form the high-risk
category of financial assets as their returns depend on many uncontrollable factors.
The characteristics / features of investments can be summarised as return, risk, safety, and
liquidity, marketability, capital growth, purchasing power, stability and the benefits.
1. Return / Income: Return refers to expected rate of return from an investment. Infact,
investments are made with the primary objective of deriving a return and Investor always
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prefers to high rate of return for his investment. The expectation of a return may be from
income (yield) as well as through capital appreciation. Capital appreciation is the difference
between the sale price and the purchase price of the investment. The dividend or interest from
the investment is the yield.
2. Risk: Risk is inherent in any investment. Risk refers to the loss of capital, delay in repayment of
capital, non-payment of interest, or variability of returns. While some investments such as
government securities and bank deposits are almost without risk, others are more risky. The
risk of an investment is determined by the investment’s maturity period repayment capacity,
nature of return commitment, and so on.
3. Safety: Safety refers to the protection of investors principal amount and expected rate of
return. It is identified with the certainty of return of capital without loss of money or time.
Every investor expects to get back the initial capital on maturity without loss and without delay.
For example, investment is considered safe especially when it is made in securities issued by
the government of a developed nation.
4. Liquidity: Liquidity refers to convertibility in to cash. It reflects the feasibility of converting of
the asset into cash quickly and without affecting its price significantly. An investment that is
easily saleable or marketable without loss of money and without loss of time is said to possess
the characteristic of liquidity. For an investment to be liquid it must be (1) reversible or (2)
marketable. The difference between reversibility and marketability is that reversibility is the
process whereby the transaction is reversed or terminated while marketability involves the sale
of the investment in the market for cash.
5. Marketability: Marketability means transferability or saleability of an asset. Shares which are
listed in a stock market are more easily marketable than which are not listed. Public Limited
Companies shares are more easily transferable than those of private limited companies.
6. Capital Growth / capital appreciation : Capital Growth refers to appreciation of the value of an
investment or increase in the value of an asset and Capital appreciation has today become an
important principle in investment. Capital growth is measured on the basis of the current value
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of the asset or investment, in relation to the amount originally invested in it. For example in the
case of shares, capital growth is an increase in share price compared to what you paid at the
time of purchase.
7. Purchasing Power Stability: It refers to the buying capacity of investment in market. Purchasing
power stability has become one of the import traits of investment. Since an investment nearly
always involves the commitment of current funds with the objective of receiving greater
amounts of future funds, the purchasing power of the future fund should be considered by the
investor.
8. Stability of Income. Another major characteristic feature of the Investment is the stability of
income and it refers to constant return from an investment. Every investor always considers
stability of monetary income and stability of purchasing power of income.
9. Tax Benefits: Tax benefits is the last characteristic feature of the investment. Some people
invest their money in various financial products solely for reducing their tax liability. For
example salaried employees sometimes invest money in Provident Fund / Pension funds in
order to avail tax benefits under section 80 C of the Income Tax Act.
While making investment investors also consider the income / profit generated from
investment and the income tax to be paid on that income.
10. Legality : While making an investment, an investor should also consider the legality of
investment. Money spent on illegal investments may cause serious legal problems and threat
to the investor.
11. Concealability : Some investors prefers investments which can be concealed and leave no
record of income received from them. It is required to be safe from social disorders,
government confiscations or unacceptable levels of taxation. Gold and precious stones have
long been esteemed for these purposes, because they combine high value with small bulk and
are readily transferable.
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12. Tangibility : Some investors prefer to invest their money in tangible assets like building , land
etc because of the pride of its possession.
Types of investments.
Investments may be classified as financial investments or economic investments. A
financial investment is an asset that you put money into with the hope that it will grow or
appreciate into a larger sum of money. The idea is that you can later sell it at a higher price or
earn money on it while you own it.
So in the financial sense, investment is the commitment of funds to derive future income
in the form of interest, dividend, premium, pension benefits, or appreciation in the value of the
initial investment. Hence, the purchase of shares, debentures, post office savings certificates, and
insurance policies are all financial investments.
Krishnamurthy Nagarajan and G. Jayabal define economic investment as “investment that
increases the "capital stock" of society” -- in other words, it increases production capacity.
Economic investment allows companies to provide more or better products and services. New
buildings, equipment and vehicles obviously represent economic investment. Economic
investments are made with the expectation of increasing the production of other goods and
services. It means the production of capital goods - goods which are not consumed but instead
used in future production. Examples include • Building • A rail road • A Factory
Types of Investors.
There are two types of investors:
_ individual investors; & _ Institutional investors.
Individual investors are individuals who are investing on their own. Sometimes individual investors
are called retail investors. Institutional investors are entities such as investment companies,
commercial banks, insurance companies, pension funds and other financial institutions.
Direct versus indirect investing.
Investors can use direct or indirect type of investing. Direct investing is realized using
financial markets and indirect investing involves financial intermediaries. The primary difference
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between these two types of investing is that applying direct investing investors buy and sell
financial instruments / assets like shares or debentures and manage individual investment
portfolio themselves. Therefore direct investors take all the risk and their successful investing
depends on their understanding of financial markets, its fluctuations and on their abilities to
analyze and to evaluate the investments and to manage their investment portfolio. But in indirect
type of investing, investors are buying or selling financial instruments of financial intermediaries
(financial institutions) who invest large amount of funds in the financial markets.
Investment vs. Speculation
Investment and speculation both involve the purchase of assets such as shares and
securities, with an expectation of return. However, investment can be distinguished from
speculation by risk bearing capacity, return expectations, and duration of trade.
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. Investment in fixed deposit in a
nationalised bank, or a Post Office Savings Deposit or purchase of a reputed companies share , all
may be regarded as genuine investments. Each person seems to have made carefully thought out
decision and each has only calculated risk. Speculative investments on the other hand are not
carefully thought out decisions. They are based on rumours, hot tips, or simply on guess based on
intuition rather than fact.
The capacity to bear risk distinguishes an investor from a speculator. An investor prefers low risk
investments, whereas a speculator is prepared to take higher risks for higher returns. Speculation
focuses more on returns than safety, thereby encouraging frequent trading without any intention
of owning the investment.
The speculator’s motive is to achieve profits through price change, that is, capital gains are
more important than the direct income from an investment. Thus, speculation is associated with
buying low and selling high with the hope of making large capital gains.
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Investors are careful while selecting securities for trading. Investments, in most instances,
expect an income in addition to the capital gains that may accrue when the securities are traded
in the market.
Investment is long term in nature. An investor commits funds for a longer period in the
expectation of holding period gains. However, a speculator trades frequently; hence, the holding
period of securities is very short.
Investor Speculator
Planning An investor has a longer A speculator has a relatively
planning horizon. His holding short planning horizon. His
period is usually at least one holding may be a few days to
year. a few months.
Risk disposition An investor is normally not A speculator is ordinarily
willing to assume more than willing to assume high risk.
moderate risk. Rarely does
he assume high risk.
Return expectation An investor usually seeks a A speculator looks for a high
modest rate of return rate of return in exchange
because of low risk he takes. for the high risk borne by
him.
Basis of decisions An investor attaches greater A speculator relies more on
significance to fundamental rumour , technical charts and
factors and attempts a market psychology.
careful evaluation of the
prospects of the firm before
investing.
Source of fund / Leverage Typically an investor uses his A speculator normally
own funds and avoid resorts to borrowings, to
borrowed funds supplement his personal
resources.
Stability of Income Income is very stable Income is uncertain
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Investment Vs Gambling
Investment can also to be distinguished from gambling. Examples of gambling are horse
race, card games, lotteries, and so on. Gambling involves high risk not only for high returns but
also for the associated excitement. Gambling is unplanned and unscientific, without the
knowledge of the nature of the risk involved. It is surrounded by uncertainty and a gambling
decision is taken on unfounded market tips and rumours. In gambling, artificial and unnecessary
risks are created for increasing the returns.
Investment is an attempt to carefully plan, evaluate, and allocate funds to various
investment outlets that offer safety of principal and expected returns over a long period of time.
Investment management
Investment management is the professional asset management of various securities
(shares, bonds and other securities) and other assets (e.g., real estate) in order to meet specified
investment goals for the benefit of the investors.
NEED AND IMPORTANCE OF INVESTMENTS
An investment is an important and useful factor in the context of present day conditions.
Some factors are important. They are as outlined below:
1. Longer Life Expectancy: Investment decisions have become more significant as most people in
India retire between the ages of 56 to 60. So that, they are planned to save their money. Saving
by themselves do not increase wealth, saving must be invested in such a way that the principal
and income will be adequate for a greater number of retirement years. Longer life expectancy
is one reason for effective saving and further investment activity that help for investment
decisions.
2. Increasing Rates of Taxation: Taxation is one of crucial factors in any country, which
introduces an element of compulsion in a person's savings. There are various forms of
investment schemes in our country which help in bringing down the tax level by offering
deductions in personal income. When the tax payer invest their income into provident fund,
pension fund, Life Insurance, Post Office Cumulative Deposit Schemes etc, it reduces the tax
burden.
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3. Interest Rates / rate of return : Interest rate is one of the most important aspects of a sound
investment plan. The interest rate differs from one investment to another. There may be
changes between degree of risk and safety of investments. They may also differ due to
different benefit schemes offered by the institutions. A high rate of interest may not be the
only factor favouring the selection of investment. Stability of interest is also an important
aspect of receiving a high rate of interest.
4. Inflation: Inflation is the general increase in prices and fall in the purchasing value of money.
Inflation has become a continuous problem as it affects in terms of rising prices. A good
investment can earn profit / interest / returns that are equal to or greater than inflation and
preserve and enhance purchasing power.
5. Income: Income is another important element of the investment for majority of investors.
People near or in retirement are fond of this strategy for obvious reasons. Debentures, Bonds,
etc provide a fixed income to the investors, while equity shares provide variable income.
6. Investment Channels: The growth and development of the country has led to the introduction
of a number of investment opportunities. Apart from putting aside savings in savings banks
where interest is low, investors have the choice of a variety of instruments like shares,
debentures, mutual funds and so on.
FACTORS FAVOURABLE FOR INVESTMENT
The investment market should have a favourable environment to be able to function
effectively. Generally, there are four basic considerations which foster growth and bring
opportunities for investment. These are (a) legal safeguards, (b) stable currency, (c) existence of
financial institutions to aid savings and (d) form of business organisation.
(a) Legal Safeguards: A stable government, which frames adequate legal safeguards, encourages
accumulation of savings and investments. Investors will be willing to invest their funds if they,
have the assurance of protection of their contractual and property rights.
(b) A Stable Currency : A well organised monetary system with definite planning and proper
policies is a necessary pre-requisite to an investment market. Price inflation destroys the
purchasing power of investments.
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(c) Existence of Financial Institutions to Encourage Savings: The presence of financial
institutions which encourage savings and direct them to productive uses helps the investment
market to grow. The financial institutions generally in existence in most countries are
commercial banks, life insurance companies and investment companies.
(d) Form of Business Organization: The form of Business Organization which is permanent in
existence aids savings and investment. The public limited companies have been said to be the
best form of organization, because of limited liability to shareholders, perpetual life and
transferability and divisibility of stocks & shares.
Types of Investors
Many successful investors adopt an investment strategy that fits their goals and tolerance for risk.
Investment strategies can be selected on the basis need and goal in life.
a) Growth Investors
As the name implies, growth investors look for the investment in rising companies. They
are interested in companies that have high potential for earning growth. High earning growth
invariably leads to high stock prices. Growth investors are willing to invest on young (or not so
young) companies that show promise of becoming leaders in their industry. The IT stocks,
especially during the late 1990s, were the perfect example of growth stocks. Many of the young
companies started with an idea and nothing more and now are large successful companies.
b) Value Investors
Value investors look for the stocks that the market has overlooked. These are stocks the
market has passed over while chasing some other industry sector or more glamorous investments.
The value investor looks for stocks with a low price/earnings Assuming the company is solid, the
value investor's strategy is to buy and hold the stock, anticipating the future time when the
market will recognize the company's worth and bid the stock up to its true value. Assuming the
company is solid, the value investor's strategy is to buy and hold the stock, anticipating the future
time when the market will recognize the company's worth and bid the stock up to its true value.
c) Income Investors
Income investing is the most straight-forward of all strategies and the most conservative. Income
is the motivation and investors target companies paying high and consistent dividends. People
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near or in retirement are fond of this strategy for obvious reasons. The companies that qualify for
the income investor tend to be large and well-established.
d) Buy and Hold investors
Buy and hold investors believe ‘time in the market’ is a more prudent investment style. The
strategy is applied by buying investment securities and holding them for long periods of time.
e) Fundamental Investors
Fundamental analysis is a form of an active investing strategy that involves analyzing financial
statements for the purpose of selecting quality stocks. Data from the financial statements is used
to compare with past and present data of the particular business or with other businesses within
the industry. By analyzing the data, the investor may arrive at a reasonable valuation (price) of the
particular company's stock and determine if the stock is a good purchase or not.
f) Technical Investors
Investors using technical analysis (technical traders) often use charts to recognize recent price
patterns and current market trends for the purpose of predicting future patterns and trends. In
different words, there are particular patterns and trends that can provide the technical trader
certain cues or signals, called indicators, about future market movements. When these patters
begin to take shape and are recognized, the technical trader may make investment decisions
based upon the expected result of the pattern or trend.
g) Angel Investor
An angel investor, sometimes just referred to as an angel, is an individual who invests private
funds in a company or product for personal reasons. Motivations for angel investors include
interest in a particular area or a belief in the product, as well as more personal reasons.
h) Active Investors
An active investor is one that has an explicit or implicit objective of "beating the market." In
simple terms, the word active means that an investor will try to pick investment securities that
can outperform a broad market index. These individuals have a high-risk tolerance and less of a
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need for security. Active investors are more likely to invest on the basis of their experience and
expertise.
i) Passive Investors
The passive investing strategy can be described by the idea that “if you can’t beat them, join
them." To these investors security is more important than risk.
j) Emotional Investors
Emotional investors make decisions by impulse or hype and they have great difficulty disengaging
from poor investments or cutting losses. These investors are easily attracted to fashionable
investments or ‘hot’ tips, and act with their heart and not their head.
RISK
According to the Oxford dictionary risk is, “The possibility of meeting danger or of suffering
harm or loss.” . Risk in investment is generally associated with the possibility that realized returns
of securities will be less than the returns that were expected. The source of such risk is the failure
of dividends (interest) and/or the security’s price to materialize as expected.
There are numerous forces that contribute to variations in return— price or dividend
(interest). These forces are termed as elements of risk. Some factors are external to the firm and
cannot be controlled. These factors affect large numbers of securities. In investments, those forces
that are uncontrollable, external, and broad in their effect are called sources of systematic risk.
Other forces are internal to the firm and are controllable to a large degree. The controllable,
internal factors somewhat peculiar to industries and/or firms are referred to as sources of
unsystematic risk.
Systematic risk
The systematic risk is caused by factors external to the particular company and uncontrollable by
the company. It arises due to the influence of external factors on an organization. Such factors
are normally uncontrollable from an organization's point of view. Economic, political, and social
changes are sources of systematic risk. Thus it is a macro in nature as it affects a large number of
organizations.
Sources / classification of systematic risk.
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The main constituents of systematic risk include- market risk, interest rate risk and purchasing
power risk.
1. Market risk: Market risk is associated with consistent fluctuations seen in the trading price of any
particular shares or securities. That is, it is a risk that arises due to rise or fall in the trading price of
listed shares or securities in the stock market. The stock prices may fall from time to time while a
company’s earnings are rising, and vice versa, is not uncommon. The causes of this phenomenon
are varied, but it is mainly due to a change in investors’ attitudes towards equities in general, or
toward certain types or groups of securities in particular. Variability in return on most common
stocks that is due to basic sweeping changes in investor expectations is referred to as market risk.
2. Interest-rate risk. Interest rate risk is the risk that an investment's value will change as a result of
a change in interest rates. Most commonly the interest rate risk affects the debt securities like
bond, debentures.
3. Purchasing-power risk: Purchasing-power risk refers to the uncertainty of the purchasing power
of the money to be received. In simple terms, purchasing-power risk is the impact of inflation or
deflation on an investment. When we think of investment as the postponement of consumption,
we can see that when a person purchases a stock, he has foregone the opportunity to buy some
goods or service for as long as he owns the stock. If, during the holding period, prices on desired
goods and services rise, the investor actually loses purchasing power. Rising prices on goods and
services are normally associated with what is referred to as inflation. Falling prices on goods and
services are termed deflation.
2. Unsystematic risk
Unsystematic or diversifiable risk is the portion of total risks that is unique to a firm or industry.
Therefore it arises due to the influence of internal factors prevailing within an organization.
Factors like management capability, labor unions, product category, research and development,
pricing, marketing strategy, consumer preferences and raw material scarcity causes unsystematic
variability of returns in a firm. Unsystematic risk is a micro in nature as it affects only a particular
organization. Such factors are normally controllable from an organization's point of view.
Un systematic risk includes :-
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a. Business risk: Business risk is also known as operating risk. Operating risk is associated with
day to day operations of the business firm. Every company operates with in a particular
operating environment, which include both internal environment within the firm and external
environment outside the firm. Business risk is thus a function of the operating conditions
faced by a company and is the variability in operating income caused by the operating
conditions of the company. Business risk relates to the variability of the sales, income, profits
etc., which in turn depend on the market conditions for the product mix, input supplies,
strength of competitors, etc.
Business risk may be caused by a variety of factors as mention below:
• High Competition
• Emergence of New Technologies
• Development of Substitute Products
• Shifts in Consumer Preferences
• Inadequate Supply of Essential Inputs
• Changes in Government Policies
• Poor Business Performance.
b. Financial Risk: This risk arises when a company borrows money to run the business. A
company with no debt financing has no financial risk. Debt creates problems in bad times,
because the manager has to raise money to repay the interest and capital when they become
due.
c. Default or credit or insolvency risk: Credit risk is the risk that a company or individual will be
unable to pay the contractual interest or principal on its debt obligations.The borrower or
issuer of securities may become insolvent or may default, or delay the payments due, such as
interest instalments or principal repayments. Government bonds, especially those issued by
the federal government, have the least amount of default risk and the lowest returns, while
corporate bonds tend to have the highest amount of default risk but also higher interest rates.
d. Other Risks
Besides the above described risks, there are many more risks, which can be listed, but in actual
practice, they may vary in form, size and effect.
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i. Currency/Exchange Rate Risk : Currency or exchange rate risk is a form of risk that arises from the
change in price of one currency against another. The constant fluctuations in the foreign
currency in which an investment is denominated vis-à-vis one's home currency may add risk
to the value of a security.
ii. Social / legislative Risk : Risk associated with the possibility of nationalization, unfavorable
government action or social changes resulting in a loss of value is called social or regulatory
risk. Because the ruling government has the power to change laws affecting securities, any
ruling that results in adverse consequences is also known as legislative risk.
iii. Political risk may occur due to the changes in the government, or its policy shown in fiscal or
budgetary aspects, changes in tax rates, imposition of controls or administrative regulations
etc.
iv. Management risks : This risk is caused by managerial decisions and they arise due to errors
or inefficiencies of management, causing losses to the company. For example the
management may depend its activities on a single buyer or single raw material supplier.
Ignoring research and development activities and trying to sell obsolete products are also
examples of management risk.
v. Marketability - Liquidity risks results from inability of a seller to dispose the securities except
by offering price discounts and commissions. It also involve loss value in conversions from
one asset to another say, from stocks to bonds, or vice versa. Such risks may arise due to
some features of securities.
3. Individual and group risk : If a risk affects the economy or all the organisations, then it can be
called group risk. War, floods, earth quake etc are examples of such risks. Individual risks affect
only single business unit or small groups. Risks such as fire, theft or robbery are examples of such
risks.
4. Pure and speculative risks : Pure risks are those situations where possibility of loss may or may
not be there. If such a risk is insured then insurance companies will compensate for the risk. For
example accident or theft insurance for a car. Speculative risks are those risks where there is the
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possibility of profit or loss. These risks are undertaken with the intention of earning a profit, but
possibility of loss also remains. Eg. Investment in shares.
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