Topic 1 –

Introduction to investing

Chapter 1
Smart, Gitman & Joehnk, 2014, Fundamentals of Investing (12th Ed.), Boston, Pearson: Addison Welsey
What is an Investment?

• Investment: any vehicle into which funds can be

placed with the expectation that it will generate
positive income and/or that its value will be
preserved or increased
• Return: the reward for owning an investment
– Current income ( exp: dividend, interest, coupon
interest)
– Increase in value ( capital gain)

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Types of Investments

• Securities or Property
– Securities: stocks, bonds, options
– Real Property: land, buildings
– Tangible Personal Property: gold, artwork, antiques
• Direct or Indirect
 With a direct investment, an individual acquires a direct claim on a security or
property.
 For example, an investment in one share of IBM stock directly provides the
stockholder a proportionate ownership in IBM.
 An indirect investment provides an indirect claim on a security or property.
 For example, if you bought one share of Fidelity Growth Fund (a mutual
fund), you are in effect buying a portion of a portfolio of securities owned by
the fund.
 Thus, you will have a claim on a fraction of an entire portfolio of securities.
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Types of Investments (cont'd)

• Debt, Equity or Derivative Securities

– Debt: investor lends funds in exchange for interest income and
repayment of loan in future (bonds)
– Equity: represents ongoing ownership in a business or property
(common stocks)
– Derivative Securities: Options are derivative securities that allow
an investor to sell or buy another security or asset at a specific
price over a given time period.
For example, an investor might purchase an option to buy
Company X stock for $50 within nine months.

• Low Risk or High Risk

– Risk: chance that actual investment returns will differ from those
expected

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Types of Investments (cont'd)

• Short-Term or Long-Term
– Short-Term: mature within one year
– Long-Term: maturities of longer than a year

• Domestic or Foreign
– Domestic: Malaysia-based companies
– Foreign: foreign-based companies

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Suppliers and Demanders of
Funds

• Government
– Federal, state and local projects & operations
– Typically net demanders of funds
• Business
– Investments in production of goods and services
– Typically net demanders of funds
• Individuals
– Some need for loans (house, auto)
– Typically net suppliers of funds

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Figure 1.1
The Investment Process

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The Investment Process

• The investment process brings together suppliers and

demanders of funds.
• This may occur directly (as with property investments).
• More often the investment process is aided by a
financial institution (such as a bank, savings and loan,
savings bank, credit union, insurance company, or
pension fund) that channels funds to investments
• and/or a financial market (either the money market or
the capital market) where transactions occur between
suppliers and demanders of funds.
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Types of Investors

• Individual Investors
– Invest for personal financial goals
(retirement, house)
• Institutional Investors
– Paid to manage other people’s money
– Trade large volumes of securities
– Include: banks, life insurance companies,
mutual funds and pension funds

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Table 1.1
Overview of Investment Vehicles

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Steps in Investing

• Step 1: Meeting Investment Prerequisites

a. Adequately provide for necessities of life, including
funds for meeting emergency cash needs
b. Adequate protection against losses from death,
illness and disability
• Step 2: Establishing Investment Goals
Examples include:
a. Accumulating retirement funds
b. Enhancing current income
c. Saving for major expenditures
d. Sheltering income from taxes

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Steps in Investing (cont'd)

• Step 3: Adopting an Investment Plan

a. Develop a written investment plan
b. Specify target date and risk tolerance for each goal
• Step 4: Evaluating Investment Vehicles
a. Assess potential return and risk
b. Chapter 4 will cover risk in detail
• Step 5: Selecting Suitable Investments
a. Research and gather information on
specific investments
b. Make investment selections

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Steps in Investing (cont'd)

• Step 6: Constructing a Diversified Portfolio

a. Use portfolio comprised of different investments
b. Diversification can increase returns or decrease risks
(Chapter 5 will cover diversification in detail)

• Step 7: Managing the Portfolio

a. Compare actual behavior with expected performance
b. Take corrective action when needed

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Investing Decisions

• Types of Income for Individuals

– Active Income: income from working (wages,
salaries, pensions)
– Portfolio Income: income from investments (interest,
dividends, capital gains)
– Passive Income: income from special investments
(rents from real estate, royalties, limited partnerships)

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Investing Decisions
Over Investor Life Cycle

• Investors tend to follow different investment

philosophies as they move through different
stages of the life cycle.
• Youth Stage
– Twenties and thirties
– Growth-oriented investments
– Higher potential growth; Higher potential risk
– Stress capital gains over current income
• What are some examples of age-appropriate
investments?
– Common stocks, options or futures

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Investing Decisions
Over Investor Life Cycle (cont'd)

• Middle-Aged Consolidation Stage

– Ages 45 to 60
– Family demands & responsibilities become important
(education expenses, retirement savings)
– Move toward less risky investments to preserve capital
– Transition to higher-quality securities with lower risk
• What are some examples of age-appropriate
investments?
– Low-risk growth and income stocks, preferred stocks,
convertible stocks, high-grade bonds

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Investing Decisions
Over Investor Life Cycle (cont'd)

• Retirement Stage
– Ages 60 and older
– Preservation of capital becomes primary goal
– Highly conservative investment portfolio
– Current income needed to supplement
retirement income
• What are some examples of age-
appropriate investments?
– Low-risk income stocks and mutual funds, government
bonds, quality corporate bonds, bank certificates of
deposit
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Investing in Different
Economic Environments

• Market Timing: process of identifying the current

state of the economy/market and assessing the
likelihood of its continuing on its present course
• Three Conditions of the U.S. Economy
– Recovery or expansion
• Corporate profits are up, which helps stock prices
• Growth-oriented and speculative stocks do well
– Decline or recession
• Values and returns on common stocks tend to fall
– Change in the general direction of the economy’s
movement

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Figure 1.2 Different Stages
of an Economic/Market Cycle

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The Role of Short-Term Vehicles

• Liquidity: the ability of an investment to be

converted into cash quickly and with little or
no loss in value
• Primary use is for emergency cash reserve
or to save for a specific short-term
financial goal

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The Advantages and Disadvantages
of Short-Term Vehicles

• Advantages
– High liquidity
– Low risks of default

• Disadvantages
– Low levels of return
– Loss of potential purchasing power
from inflation

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Table 1.3 U.S Popular Short-Term
Investment Vehicles (Part A)

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Table 1.3 U.S Popular Short-Term
Investment Vehicles (Part B)

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Table 1.3 U.S Popular Short-Term
Investment Vehicles (Part C)

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Investment Suitability

• Short-Term Vehicles are used for:

– Savings
• Emphasis on safety and security instead
of high yield
– Investment
• Yield is often as important as safety
• Used as component of diversified portfolio
• Used as temporary outlet waiting for attractive
permanent investments

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