INVESTMENT

Investment is an activity that is engaged in by people who have savings, i.e., investments are made from
savings, or in other words, people invest their savings. But all savers are not investors. Investment is an activity
which is different from saving. Investment is the employment of funds with the aim of achieving additional
income or growth in value. Investment has two attributed namely time and risk. Present consumption is
sacrificed to get a return in the future. The sacrifice that has to be borne is certain but the return in the future may
be uncertain. This attribute of investment indicates the risk factor. The risk is undertaken with a view to reap
some return for the investment.
FINANCIAL AND ECONOMIC MEANING OF INVESTMENT
Investment is the allocation of monetary resources to assets that are expected to yield some gain or
positive return over a given period of time. These assets range from safe investments to risky investments in this
form are also called Financial Investments.
In the economic sense, investment means the net additions to the economys capital stock which consists
of goods and services that are used in the production of other goods and services. Investment in this sense
implied the formation of new and productive capital in the form of new constructions, plant and machinery,
inventories etc., such investments generate physical assets.
The two types of investments are, however, related and dependent. The money invested in financial
investments are ultimately converted into physical assets. Thus, all investments result in the acquisition of some
assets either financial or physical.
CHARACTERISTICS OF INVESTMENT
All the investments are characterized by certain features.

The following characteristic features of

investment:
Return: All investments are characterized by the expectation of a return. In fact, investments are made with the
primary objective of deriving a return. The return may be received in the form of yield plus capital appreciation.
The difference between the sale price and the purchase price is capital appreciation. The interest or dividend or
interest received from the investment is the yield. Different types of investments promise different rates of
returns. The return from an investment depends upon the nature of the investment, the maturity period and a host
of other factors.
Risk: Investments risk is just as important as measuring its expected rate of return because minimizing risk and
maximizing the rate of return are interrelated objectives in the investment management. The risk of an investment
depends on the following factors:
The longer the maturity period, the larger is the risk
The lower the credit worthiness of the borrower, the higher is the risk
The risk varies with the nature of investment. Investments in ownership securities like equity shares carry
higher risk compared to investments in debt instruments like debentures and bonds.
Risk and return of an investment are related. Normally, the higher the risk, the higher is the return.

Safety: The safety of an investment implied the certainty of return of capital without loss of money or time.
Safety is another feature which an investor desires for his investments. Every investor expects to get back his
capital on maturity without loss and without delay.
Liquidity: Marketability of the investment provides liquidity to the investment. The liquidity depends upon the
marketing and trading facility. If a portion of the investment could be converted into cash without much loss of
time, it would help the investor meet the emergencies. Some investments like company deposits, bank deposits,
Post Office Deposits, National Saving Certificates etc. are not marketable. Some investment instruments like
preference shares and debentures are marketable, but there are no buyers in many cases and hence their liquidity
is negligible. Equity shares of companies listed on stock exchanges are easily marketable through the stock
exchanges.
OBJECTIVES OF INVESTMENT
The objectives of an investor can be stated as:
1. Maximization of return
2. Minimization of risk
3. Hedge against inflation
Investors, in general, desire to earn as large returns as possible with the minimum of risk. Risk here may be
understood as the probability that actual returns realized form an investment may be different from the
expected return. If we consider the financial assets available for investment, we can classify them into
different risk categories. Government securities would constitute the low risk category as they are practically
risk free. Debentures and preference shares of companies may be classified as medium risk assets. Equity
shares of companies would form the high risk category of financial assets. An investor would be prepared to
assume higher risk only if he expects to get proportionately higher returns there is a tradeoff between risk and
return. The expected return of an investment is directly proportional to its risk. The expected return of an
investment is directly proportion to its risk. Thus, in the financial market, there are different financial assets
with varying risk return combinations.
The investors in the financial market have different attitudes towards risk and varying levels of risk
bearing capacity. Some investors are risk averse while some may have an affinity to risk. The risk bewaring
capacity of investors, on the other hand, is a function of his income. A person with higher income is assumed
to have higher risk bearing capacity. Each investor tries to maximize his welfare by choosing the optimum
combination of risk and expected return in accordance with his preference and capacity.
INVESTMENT VS SPECULATION
Investment and speculation are two terms which are closely related. Both involve purchase of assets like
shares and securities. Traditionally, investment is distinguished from speculation with respect to three factors
viz., risk, capital gain and time period.
Risk: It refers to the possibility of incurring a loss in a financial transaction. It arises from the possibility of
variation in returns from an investment. Risk is invariably related to return. Higher return is associated with
higher risk.

No investment is completely risk free. An investor generally commits his funds to low risk investment,
whereas a speculator commits his funds to higher risk investments. A speculator is prepared to take higher
risk in order to achieve higher returns.
Capital Gain: Another distinction between investment and speculation emphasizes that if the motive is
primarily to achieve profits through price changes, it is speculation. If purchase of securities is lead by proper
investigation and analysis and review to receive a stable return over a period of times it is termed as
investment.

Thus, buying low and selling high, thus making a large capital gain is associated with

speculation.
Time Period: Investment is long term nature, whereas speculation is short term. An investor commits his
funds for a longer period and waits for his return. But a speculator is interested in short term trade gains
through buying and selling of investment instruments.
DIFFERENCE BETWEEN THE INVESTOR AND THE SPECULATOR
Factor
Time
Horizon

Investor
Speculator
Plans for a longer time horizon
Plans for a very short Period
His holding period may be form one year Holding period varies from few days to
to few years
months
Risk
Assumes moderate risk
Willing to undertake high risk
Return
Likes to have moderate rate of return Likes to have high returns for assuming
associated with limited risk
high risk
Decision
Considers fundamental factors and Considers inside information, here says
evaluates the performance of the company and market behaviour
regularly
Funds
Uses his own funds and avoids borrowed Uses borrowed funds to supplement his
funds
personal resources.
INVESTMENT PROCESS
The investment process involves a series of activities leading to the purchase of securities or other
investment alternatives. The investment process can be divided into five stages (i) framing of investment policy
(ii) investment analysis (iii) Valuation (iv) Portfolio Construction (v) Portfolio evaluation.
Investment Policy: The first stage determines and involves personal financial affairs and objectives before
making investments. It may also be called preparation of investment policy stage. The investor has to see that he
should be able to create an emergency fund, an element of liquidity and quick convertibility of securities into
cash. This stage may, therefore, be considered appropriate for identifying investment assets and considering the
various features of investments.
Security Analysis: When a individual has arranged a logical order of the types of investments that he requires on
his portfolio, the next step is to analyse the securities available for investment. He must make a comparative
analysis of the type of industry, kind of security and fixed vs variable securities. The primary concerns at this
stage would be to form beliefs regarding future behavior or prices and stocks, the expected returns and associated
risk.
Valuation of Securities: The third step is perhaps the most important consideration of the valuation of
investments. The valuation helps the investor to determine the return and risk expected from any investment in

the common stock. The intrinsic value of the share is measured through the book value of the share and price
earnings ratio. Simple discounting models also can be adopted to value the share. The stock market analysts have
developed many advanced models to value the shares. The real worth of the share is compared with the market
price and then the investment decisions are made. Future value of the securities could be estimated by using a
simple statistical technique like trend analysis. The analysis of the historical behavior of the price enables the
investor to predict the future value.
Portfolio Construction: A portfolio is combination of securities. The portfolio is constructed in such a manner to
meet the investors goals and objectives. The investor should decide how best to reach the goals with the
securities available. The investor tries to attain maximum return with minimum risk. Towards this end he
diversifies his portfolio and allocates funds among the securities.
(a) Diversification: the main objective of diversification is the reduction of risk in the loss of capital and
income. A diversified portfolio is comparatively less risky than holding a single portfolio.
(b) Debt and Equity Diversification: Debt instruments provided assured return with limited capital
appreciation. Common stocks provide income and capital gain but with the favour of uncertainty. Both
debt instruments and equity are combined to complement each other.
(c) Industry Diversification: Industries growth and their reaction to government policies differ from each
other. Banking industry shares may provide regular returns but with limited capital appreciation.
(d) Company Diversification: Securities from different companies are purchased to reduce risk. Technical
analyst suggests the investors to buy securities based on the price movement. Fundamental analyses
suggest the selection of financially sound and investor friendly companies.
(e) Selection: Based on the diversification level, industry and company analyses the securities have to be
selected.

Funds are allocated for the selected securities and the allocation of funds and seal the

construction of portfolio.
Portfolio Evaluation: The portfolio has to be managed efficiently. The efficient management calls for evaluation
of the portfolio. This process consists of portfolio appraisal and revision.
(a) Appraisal: The return and risk performance of the security vary from time to time. The variability in
returns of the securities is measured and compared. The developments in the economy, industry and
relevant companies from which the stocks are bough have to be appraised. The appraisal wants the loss
and steps can be taken to avoid such losses.
(b) Revision: Revision depends on the results of the appraisal. The low yielding securities with high risk are
replaced with high yielding securities with low risk factor. To keep the return at a particular level
necessitates the investor to revise the components of the portfolio periodically.
PRIMARY MARKET
The primary market is also known as new issues market. Here, the transaction is conducted between the issuer
and the buyer. In short, the primary market creates new securities and offers them to the public.
For instance, Initial Public Offering (IPO) is an offering of the primary market where a private company decides
to sell stocks to the public for the first time. An important point to remember here is that in the primary market,
securities are directly purchased from the issuer.

Capital or equity can be raised in primary market by any of the following four ways:
1. Public Issue
As the name suggests, public issue means selling securities to public at large, such as IPO. It is the most vital
method to sell financial securities.
2. Rights Issue
Whenever a company needs to raise supplementary equity capital, the shares have to be offered to present
shareholders on a pro-rata basis, which is known as the Rights Issue.
3. Private Placement
This is about selling securities to restricted number of classy investors like frequent investors, venture capital
funds, mutual funds and banks comes under Private Placement.
4. Preferential Allotment
When a listed company issues equity shares to a selected number of investors at a price that may or may not be
pertaining to the market price is known as Preferential Allotment.
The primary market is also known as the New Issue Market (NIM) as it is the market for issuing long-term equity
capital. Since the companies issue securities directly to the investors, it is responsible to issue the security
certificates too. The creation of new securities facilitates growth within the economy.
SECONDARY MARKET
In secondary market, the securities issued in the primary market are bought and sold. Here, you can buy a share
directly from a seller and the stock exchange or broker acts as an intermediary between two parties.
The secondary market is actually formed by another layer of investors who deal with primary market investor to
buy and sell financial securities such as bonds, futures and stock. These dealings happen in the proverbial stock
exchange.
National Stock Exchange (NSE) and New York Stock Exchange (NYSE) are some popular stock exchanges.
Majorly, the trade happens between investors without any involvement with the company that issued the securities
in the primary market. pThe secondary market is further divided into two kinds of market.

1. Auction Market
The auction market is a place where buyers and sellers convene at a place and announce the rate at which they are
willing to sell or buy securities. They offer either the bid or ask prices, publicly. Since all buyers and sellers are
convening at the same place, there is no need for investors to seek out profitable options. Everything is announced
publicly and interested investors can make their choice easily.
2. Dealer Market
In a dealer market, none of the parties convene at a common location. Instead, buying and selling of securities
happen through electronic networks which are usually fax machines, telephones or custom order-matching
machines. Interested sellers deliver their offer through these mediums, which are then relayed over to the buyers

through the medium of dealers. The dealers possess an inventory of securities and earn their profit through the
selling. A lot of dealers operate within this market and therefore, a competition exists between them to deliver the
best offer to their investors. This makes them deliver the best price to the investors. An example of a dealer
market is the NASDAQ.
The secondary markets are important for price discovery. The market operations are carried out on stock
exchanges.
A variation to the dealer market is the OTC market. OTC stands for Over the Counter market. The concept came
into existence during the early 1920s period through Wall Street trading, which implied the prevalence of an
unorganized system of dealers who conducted trades via networks. Stock shops existed to buy and sell shares
over-the-counter. In other words, these were unlisted stocks which were sold privately.
Over time, the notion of OTC underwent a change. These days the over-the-counter denotes those stocks which
are not traded over NYSE, NASDAQ or American Stock Exchange (AMEX). The over-the-counter implies those
stocks which are traded on the pink sheets or on over-the-counter bulletin boards (OTCBB). Pink sheets are a
name given to the daily list of stocks published with ask and bid prices by the National Quotation Bureau. The
OTCBB service is offered by the National Association of Securities Dealers (NASD) which accurately displays
the last sale prices, real time quotations and other volume information of over-the-counter securities.