INVESTMENT

1.1 Definition
Oxford Advanced Learner‟s Dictionary defines the term investment as, „A thing that
is worth buying because it may be profitable or useful in the future.‟

Webster‟s Third New Dictionary defines the term investment as, „An expenditure of
money for income or profit in purchasing something of intrinsic value. It is the
commitment of funds with a view of minimising risk and safeguarding capital while
earning a return, as contrasted to speculation.‟ Speculation on the other hand is

defined as, „The act of engaging in business out of the ordinary dealing with a view of
making a profit from conjectural fluctuations in the price rather than from earnings of
the ordinary profit of trade, or by entering into a business venture involving unusual
risks for chance of an unusually large gain or profit.‟ Speculation is essentially the act
of forming opinions without having definite or complete knowledge/facts.

Any investment is basically characterised by the foregoing of a capital sum in return

for a regular income over a period of time. (Richmond, 1975)

According to Enever, „Investment is the giving up of a capital sum now in exchange

for benefits to be received in the future.‟ (Enever and Isaac, 1994)

A more comprehensive definition is that by Merret and Sykes (1973) who stated that,
„The defining characteristic of an investment is the outlay of valuable resources in the
expectation of future gain.‟

The valuable resources can either be in the form of a capital sum or something of
value. In its simplest sense, an investment is the outlay of cash in one period in the
expectation of the return of a larger sum in the following period. The capital
expenditure could be all at once or in small regular amounts with a view of them
producing larger cash flows at various times in the future. Future gain or benefits can
take the form of regular income flows and/or capital gain. There is also what is known
as psychic income, that is, the good feeling one gets just from owning something. It is
not monetary in nature.

All things being equal, an investor will choose an investment which maximises his
return on capital invested.
1.2 Motivations for Investors/Why people invest?
Suffice it to say, the majority of investors are individuals, groups of individuals,
institutions and organisations that have surplus financial resources; surplus in the
sense that they have more money at their disposal than is enough to meet their
immediate requirements. There are a variety of reasons as to why people invest their
money and they are summarised below.
i) To earn an income/interest payments
ii) For capital/price appreciation
iii) Diversification purposes
iv) Tax benefits
v) Convenience in accumulating wealth
vi) Marketability

1.3 Qualities of Investments

There exists a wide investment spectrum from which a potential investor can make a
choice as to where to invest his capital. In making a choice, there are a number of
qualities that guide a potential investor. Investments have many qualities and it is
possible to list all of them but some are more important than others and hence will be
regularly considered by the average investor when making an investment choice.
These are collectively termed the qualities of the „ideal‟ or „perfect‟ investment.
These include mainly:
i) Security of capital with speed of capital recapture
ii) Security of income
iii) Ease of purchase or sale with minimal costs
iv) Minimal management costs
v) Homogeneity and divisibility
vi) Security in real terms (hedge against inflation)
vii) Presence of adequate information and a wide market
viii) Minimal government interference

i) Security of Capital
Security of capital is the most important feature investors look for when making a
choice amongst the available investments. Few investors would be willing to put
their money in a venture where the prospect of them losing it is high. The
exception to this would be the gambler or investor with lots of money so is able to
risk losing some and in most cases; it is only when, if all goes well, there is a large
possibility of them making a substantial gain from the investment. The majority of
investors will be willing to place their money in an investment where there is a
great chance of them recouping their original capital sometime in the future should
the need arise. The greater the security of capital (or the higher the chances of
them getting their original capital back), the greater will be their willingness to
invest.

ii) Security of Income

In investing one‟s money, one is giving up the use of it and letting someone else
use it. As is with the hiring out of assets such as vehicles where the vehicle owner
is paid a hire fee, the investor expects to be paid for letting someone else use his
money. The money the investor expects to be paid is the interest his money will be
earning for him. In this regard therefore, before the investor can give up the use of
his money, he needs to be quite certain that this interest will in fact be paid and
not only that but that it will be adequate.

In addition, the investor would require that the income he receives from his capital
(interest earned) is at regular intervals. This will enable the borrower avoid getting
into arrears as well as enabling the investor to arrange his expenditures to match
the interest payments (receipts) and also aid him in his financial (or budgetary)
control.

iii) Ease of Purchase

The costs involved in acquiring the investment also do matter. Some investments
involve a substantial number of costs during their purchase hence posing a
hindrance to investors. These costs may take the form of time spent acquiring the
investment, professional fees involved, stamp duty to be paid, the amount of
paperwork to be done and others.

Ease of Sale (Liquidity)

This is particularly important where by the investor is likely to require his capital
on relatively short notice. In the event of such, it would be unwise for an investor

to have placed his capital in an investment that requires advance notice before
withdrawal of his funds unless such notice is very short indeed. Most investments
requiring advance notice before withdrawal of investor‟s capital have this notice
in terms of months (2 to 3 months) and not days. This can likely cause the investor
to undertake unnecessary borrowing hence disrupting his financial position. In this
regard therefore, all things being equal, investors will be drawn to investments
where they can easily withdraw their money at one or two days notice. As such,
the cheaper it is to invest and withdraw money, the more attractive will the
investment be.

iv) Minimal Management Costs

Considering all things, investments that involve few and minimal costs of being
managed during their lifetime attract more investors than those that involve many
and quite substantial management costs. Costs come in various forms such as the
level of monitoring required from the investor, regular payments to government
authorities in taxes, amount of paperwork involved, the number of management
personnel required to mention but a few. The less the management costs, the more
attractive is the investment.

v) Homogeneity and Divisibility

On the whole, homogeneous assets (e.g. stocks and shares) are much easier to
manage and dispose off in comparison to heterogeneous ones (e.g. property).
Coupled with this is divisibility of the investment which is very important to an
investor should the event arise when he needs only part of his investment.
Investments which are capable of being expressed in smaller homogeneous units
will enable the investor to sell off a few to obtain the required capital than huge
heterogeneous indivisible ones. In the latter case, sale of the asset would leave the
investor with much more money than is required for his immediate needs and
hence he is faced with the burden of re-investing the balance at what may even be
an inconvenient time. The more homogeneous and divisible an investment is the
more attractive will it be to investors and the reverse is true.

vi) Security in Real Terms (Hedge against inflation)

Investors by default prefer investments which can produce an income at or
appreciate in value by levels which compensate for the effect of inflation at least.
The ideal investment is one where the yield is guaranteed to at least equal the
prevailing level of inflation (Scarret, 1991). It is of importance to the investor that
not only does he recoup his original capital (security of capital) but that the
investment in which he has placed his capital does appreciate at a sufficient pace
that matches the changing value of money especially during times of inflation.

What the investor requires is that at the time he withdraws his money from the
investment, he is able to purchase the same amount of goods and/or services that
 he could have been able to purchase just before investing his money. If he is able
to do so, the investment is termed as having been secure in real terms because the
real value of his money has been maintained. According to Millington (2000),

when an investment is secure in real terms it is often referred to as being a good

hedge against inflation, or inflation-proof. If at the same time also, the capital
value of the investment increases more rapidly, the more attractive will it be and
hence command a higher demand from investors.

vii) Presence of Adequate Information and a Wide Market

With the presence of a large body of knowledge on the various available
investments, investors are able to have complete market intelligence hence carry
out complete market analysis and as a result make more informed investing
decisions. A large body of published information enables better interpretation of
the markets and derivation of patterns on how they operate can be made possible.
Not only should an investment have lots of published information about it
available but also a wide market for it too (prospective buyers and sellers). All
things being equal, a wide market enables the forces of demand and supply to
operate fully and efficiently hence the price of an investment is market derived
and not controlled by a few groups of individuals or institutions.

viii) Minimal Government Interference

Investments that attract a lot of legislation or any other government action that
tends to complicate the way the investment is managed and/or affect the income
return and/or capital value tend to be avoided by investors. They tend to prefer

investments that are affected by as few and at the same time simple legal
provisions. The more legal restrictions/provisions and the more their complexity,
the less attractive will an investment be to an investor.

The overall risk a particular investment bears will involve consideration of all the

above mentioned features and perhaps other qualities which a particular investor will
consider important. To some investors, some features or qualities will be very
important while other will not in the choice of an investment in which to place their
capital. For instance, one investor may be greatly concerned as to whether he will
have security of his capital while another may be more concerned with whether he can
earn substantial income amounts. Each investor will make a choice dependant on his
personal preferences and the level of risk they are willing to take on or avoid will be a
combination of some or all of the above mentioned qualities.
Suffice it to say, the riskier an investment, the higher will be the yield an investor will
require from that investment. The term yield basically refers to the level of earnings
from an investment or the speed at which the investment will earn money. To the
layman therefore, the higher the risk associated with an investment, the higher will be
the return required by the average investor.

2.0 Investment Opportunities and Types

2.1 Investment Opportunities
There exist quite a large number of investment opportunities and include among
others:
1. Articles bought for use like machinery, cars, equipment
2. Stocks and Shares
3. Gilt-edged securities
4. Debentures
5. Local Authority Loans
6. Insurance Policies
7. Linked Insurance
8. Unit Trusts and Investment Trusts
9. Property Bonds
10. Property Shares

2.2 Types of Investments

There exist a range of classifications or headings under which the above investment
opportunities can be grouped. They include:
1. Marketable and Non-marketable investments
2. Risk-Free and Risky Investments
3. Those which yield an income return and those which do not

For the purposes of this lecture, we are focusing on risk-free and risky investments.
a) Risk-free investments
b) Risky investments

A) Risk-Free Investments
These are also known as fixed interest/income producing investments. They are
referred to as risk-free because the income from them is an assured income i.e. it
1
is definitely going to be paid. Fixed interest securities which are not index-linked
2
are typically a major component of the portfolio of major investors such as
 insurance companies and pension funds. There are mainly two kinds of risk-free
3 4
investments, gilt-edged securities and corporate fixed securities.

i) Gilt-Edged Securities
Gilts represent money borrowed by the government (i.e. they are loans where the
public is the lender) on which it pays a fixed rate of interest, i.e. the amount
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payable each year during the life of the stock is always the same, whatever
happens to market interest rates during that time (Enever and Isaac, 1994). To
finance its massive expenditure, the government issues gilts or gilt-edged
securities. The term gilt-edged is used to reflect the underlying security backing
offered by the state for it is inconceivable that the government would default on
interest payments or on redemption. As such, this kind of stock obtains a security
status against which all other forms of investment tend to be measured (Scarret,
1991).

A gilt is an interest-only loan meaning that the government will pay the interest
every period, but none of the principal will be repaid until the end of the loan. For
example, suppose Bank of Uganda wants to borrow UGX 100,000,000 for 20
years at an interest rate of 15 per cent. Bank of Uganda will therefore pay
0.15*UGX 100,000,000=UGX 15,000,000 in interest every year for 20 years. At
the end of the 20 years, Bank of Uganda will repay the UGX 100,000,000.

1
An index is a statistical measurement designed to demonstrate how the value of a variable or group
of variables change with respect to others such as time and geographical area.
2
A portfolio in this sense refers to the set of investments held by an individual or organisation.

3
‘Gilts’ are a British term also known as ‘Treasury’ stock while in the United States they are
termed ‘Bond’s.
4
‘Securities’ is the stock exchange term for stocks and shares in general.
5
A Stock is a security issued by the government, local authority or company when raising funds
needed to finance their expenditure. The term ‘stock’ is sometimes used interchangeably with
the term ‘share’.
Treasury stock may be dated or undated. Dated treasury stock arises when the
government promises to repay the original capital at a specific future period or
between two future periods. In the latter case, the government has the option of
choosing the most favourable period to them when to repay the loan. Take for
example 13% Treasury Stock 2010 and 13% Treasury Stock 20010-2015. In the
former case, the government will pay the investor interest of 13% per annum and
the original capital invested will be repaid in 2010 whereas with the latter case, the
investor will receive 13% interest per annum and his original capital will be repaid
anytime between 2010 and 2015.

When the stock is undated, it means the government makes no promise to repay
the capital at any specific time, if it all. In such an instance, the investment
becomes virtually a permanent loan, if the government cares to treat is as such
(Millington, 2000). The investor can however still recover his capital by selling
the stock on the stock/securities exchange but he may not necessarily get the full
value of the original loan because he is then subject to the market rate of interest
prevailing for his type of stock.
A major disadvantage of this type of investment is that it may fail to keep pace
with inflationary trends; there is no guarantee that the income received will have
the same purchasing power as at present (Richmond, 1975).

ii) Corporate Fixed Securities

These are mainly of two kinds; debentures (or debenture stock) and preference
shares.

a) Preference Shares
A share is a security issued by a company conferring part ownership on the
order of that share. There are two kinds of shares, ordinary shares and
preference shares. The return on share is known as a dividend. More will be
discussed on ordinary shares but the focus now is on preference shares.

A preference share is a type of security that pays a fixed dividend expressed as

a percentage of its nominal value. For example, a preference share of nominal
value UGX 1000 at 5% dividend will pay a net dividend equivalent to UGX
50. In the event of liquidation or winding up the company, holders of
preference shares rank before ordinary shareholders but after debenture
holders (loan providers) in the repayment of their capital invested.
b) Debentures
A debenture is also loan stock issued by a company and is another alternative
for a company to raise funding to facilitate its activities and expenditure as
opposed to going to the bank or another financial institution. Investors in
debentures issued by companies in sound and healthy positions are provided
with a steady and reliable income flow at a known rate of interest quoted by
the company when issuing the stock.

For a debenture to be attractive, the rate of interest quoted by the company for
the debenture should be at or about the current market rate of interest at the
time of issue. Where, during the life of the debenture, the market rates move in
a downward direction, the yield on the debenture will be above the market.

rates hence the investor is able to sell his stock at a premium and hence realize
appreciation of his capital also.

A holder of a debenture is not a part owner of the company i.e. he does not
own shares in it, but merely lends money to it. A debenture is usually secured
on specific assets of the company with a further floating charge over the
remaining assets of the company. An investor in debentures is likely to lose all
his money invested in the company if it runs into difficulty and has to be
wound up however he will rank above the shareholders in the repayment of his
loan.

Convertible debentures attract fixed interest payments but carry rights to

convert to ordinary shares at the holder‟s option subject to the terms of issue
whereas unconvertible debentures carry no such rights.

Other similar fixed interest securities are local

authority loans and national
savings certificates and savings bonds.
 B) Risky Investments
These are sometimes also known as variable interest securities

and include mainly shares, unit trusts and investment trusts.

i) Shares
As previously mentioned, the return to a share is known as a dividend and the
holder of the share (shareholder) owns part of the company that issued the
share to the order of that share. For instance, assuming a company was made
up of 10,000 shares and an investor owned 2,000 of them; it would mean that
investor owned a fifth of that company. Though the shareholder owns part of
the company, the day-to-day running/management of the same is normally
carried out by paid employees and a paid management staff with policy
decisions being made by a board of directors who are elected by all
shareholders at annual meetings.

Shares are normally traded through the stock exchange (Uganda Securities
Exchange for the case of Uganda) at current market prices. These prices reflect
the market view of the company in future investment or income earning terms.
Where shares are bought in a progressive and prosperous company, there is
also likely to be capital appreciation. This means that not only will the
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shareholders be assured of dividends but also their capital will be secure and
increase in value. Investors want to become shareholders in successful
companies and when word passes round that a particular company is doing
well, then the desire for people to buy shares in that company also will
increase. As such, this increased demand for that company‟s shares will cause
the prices of the same shares to go up in the stock market. As a result, shares
can be sold for considerably more than was originally paid for them. Suffice it
to say, not only can capital appreciation be realised from trading in shares but
also capital depreciation depending on the prevailing circumstances.

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The decision of whether to pay dividends to shareholders or retain them in the company lies in
the hands of the board of directors and the reasons for so are various.
The most notable advantage of investing in shares is that generally they are
very easily marketable and hence an investor can quickly and easily realise
money, should the need arise. However, their major disadvantage is that,
where they are traded, the stock exchange is quite a very volatile market. Although
shares are easy to sell, a sale can not necessarily be arranged at the right price hence
there is no guarantee that the investor will recoup his original capital invested. As
such, when an investor knows that he will need a specific sum of money in the future,
he is best advised not to invest in the stock/securities exchange because the capital
realised could be much less at that future date than what was originally invested. It is
not possible to accurately determine future share prices and hence an investor in
stocks and shares must always be prepared for the unexpected and must not complain
if it does happen.

ii) Unit Trusts

These are quite suitable for investors who do not have the financial resources to buy
and hold a range of shares of in a large variety of companies and/or have neither the
time nor expertise to manage the same. What happens is that the investor pays money
to the trust which in turn re-invests the money in stocks and shares of various
companies. As such, the investor is afforded the opportunity to obtain a block of
shares from the trust which in turn holds the shares of many (in most cases) leading
companies. The investor is thus able to spread his risk when investing in the stock
exchange.

The trust consists of a form of managed fund safeguarded by a trustee, which in most
cases is a bank or insurance company. The trustee holds the assets, controls the issue
of units, maintains a register of holders and overseas the general management of the
trust. The trust has no separate capital structure hence all the funds including income
belong to the unit holders.

iii) Investment Trusts

Investment trusts more or less function in the same way as unit trusts. They however
 are limited liability companies having share capital and the right to issue prior charge
capital and to raise new money by rights issues. There are several differences between
unit trusts and investment trusts but to the small investor, the most important
difference lies in the fact that; with unit trusts, capital can only be realised by selling
holdings in unit trusts to the trust managers at the price quoted by them at the time of
sale while holdings in investment trusts can be sold on the stock exchange at the
current market rate.

C) Other Investments
These include property shares, works of art and real property. For more on the
characteristics of real property as an investment, see Millington (2000).