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Investment:
In finance and business, an investment is an asset purchased for profit, whether via income, or
capital appreciation, or some combination. The entity making the investment is an investor.
Investment means commitment of funds to one or more assets that will be held over some future
time period. Investment is concerned with the management of an investor’s wealth, which is the
sum of current income and the present value of all future income (present value and compound
interest). Investment is defined as a sacrifice made now to obtain a return later. Investment
usually takes in the form of financial assets and marketable securities.
Financial Assets: Financial assets are paper claims on some issuer, such as federal government
or corporation (Bonds, shares, certificate of deposits).
Real Assets: Real assets are tangible assets (physical assets) such as gold, silver, diamonds, and
real estate.
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Markets:
A market is any organized system for connecting buyers and sellers. There are various types of
markets.
Primary markets are security markets where new issues of securities are traded. Trades on the
primary market raise capital for firms
A secondary market is a market where securities are resold. The Karachi Stock Exchange is a
secondary market. Most activity on stock exchanges is in the secondary market.. Trades on the
secondary market do not raise additional capital for firms. The secondary market is still
important. It gives liquidity to primary issues. New securities would have a lower value if they
could not be subsequently traded. It signifies value. Trading in assets reveals information and
provides a valuation of the assets. This helps to guide investment decisions.
Money market: the market for assets with a life of less than 1 year. Money market is the market
for short term highly liquid, low risk assets. This market is dominated by financial institutions,
particularly banks and governments. The maturities of money market instruments ranges from
one day to one year and are often less than 90 days such as T-bills.
Capital market: the market for assets with a life greater than 1 year. Capital market is the market
for long term fixed income securities such as stocks and bonds.
Securities:
"A legal contract representing the right to receive future benefits under a stated set of
conditions"
The piece of paper defining the property rights held by the owner is the security. A security is a
legal document that shows an ownership interest. Securities have historically been associated
with financial assets such as stocks and bonds, but in recent years have also been used with real
assets. Securitization is the process of converting an asset or collection of assets into a more
marketable forum.
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Security Groupings:
Securities are placed in one of three categories: equity securities, fixed income securities, and
derivative assets.
1) Equity Securities:
The most important equity security is common stock. Stock represents ownership interest in a
corporation. Equity securities may pay dividends from the company’s earnings, although the
company has no legal obligation to do so. Most companies do pay dividends, and most
companies try to increase these dividends on a regular basis.
2) Fixed Income Securities:
A fixed income security usually provides a known cash flow with no growth in the income
stream. Bonds are the most important fixed income securities. A bond is a legal obligation to
repay a loan’s principal and interest, but carries no obligation to pay more than this.
Interest is the cost of borrowing money. Although accountants classify preferred stock as an
equity security, the investment characteristics of preferred stock are more like those of a fixed
income security. Most preferred stocks pay a fixed annual dividend that does not change
overtime consequently. An investment manager will usually lump preferred shares with bonds
rather than with common stocks.
Conversely, a convertible bond is a debt security paying a fixed interest rate. It has the added
feature of being convertible into shares of common stocks by the bond holders. If the terms of
the conversion feature are not particularly attractive at a given moment, the bonds behave like a
bond and are classified as fixed income securities. On the other hand, rising stock prices make
the bond act more like the underlying stock, in which case the bond might be classified as an
equity security.
The point is that one cannot generalize and group all stock issues as equity securities and all
bonds as fixed income securities. Their investment characteristics determine how they are
treated.
3) Derivative Assets:
Derivative assts have received a great deal of attention in the 1990s. A derivative asset is
probably impossible to define universally. In general, the value of such an asset derives from the
value of some other asset or the relationship between several other assets. Future and options
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contracts are the most familiar derivative assets. These building blocks of risk management
programs are used by all large investment houses and commercial banks.
1. Treasury Bills
US Treasury Bills are the least risky and the most marketable of all money
markets instruments
New 91- and 182- day T-bills are issued weekly, by auction whereas 52-week T-
bills are issued monthly.
An active secondary market with very low transactions costs exists for trading T-
bills
T-bills are sold at a discount from face value and pay no explicit interest
payments.
T-bills are considered to have no risk of default, have very short-term maturities,
and have a known return
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Instruments having maturities greater than one year and those having no
designated maturity at all
Failure to meet any specific payment puts the bond into default with all remaining
payments. The creditor can put the defaulter into bankruptcy
Fixed income securities differ from each other in promised return for several
reasons
The government issues fixed income securities over a broad range of the maturity
spectrum
Both notes and bonds pay interest twice a year and repay principal on the maturity
date
b) Corporate bonds
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These bonds are issued by business entities and thus have a risk of default
b. After holders of debt claims are paid, the management of the company can
either pay out the remaining earnings to stockholdings in the form of
dividends or reinvest part or all of the earnings
c. The holder of a common stock has limited liability – the most they can lose is
the value of the shares
d) Derivative instruments
Derivative instruments are securities whose value derives from the value of an underlying
security or basket of securities. The instruments are also known as contingent claims, since their
values are contingent on the performance of underlying assets. The most common contingent
claims are options and futures
An option on a security gives the holder the right to either buy (a call option) or sell (a put
option) a particular asset at a future date or during a particular period of time for a specified price
A future is the obligation to buy or sell a particular security or bundle of securities at a particular
time for a stated price. A future is simply a delayed purchase or sale of a security
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