The term investment refers to the employment of funds are with the aim of achieving additional income or growth in value. The essential quality of an investment is that it involves waiting for a reward. It takes that the commitment of resources which have been saved on put away from the current consumption. In the hope that some benefit will accure in future . Thus investment may be defined as “commitment of funds made in the exception of some positive rate of return”. The expectation of result is as essential element of investment. Since the return is expected to be realized in future. There is a possibility that the return actually realized is lower than the return expected to be realised. This possibility of variation in the actual return is known as investment risk. Thus every investment involves return and risk.
Investment may be classified into:-
1. Financial investment
Investment to the allocation of monetary resources to asset that are expected to yield some gain or return on the form of interest, dividend, premeium, pension benefit or appreciation in the value of capital. These assets renge from safe investment to risky investment. Investment in this forms called financial investment. Purchase of shares, dubuntures, post office savings certificates, insurance policies are all investments in financial sense.
2. Economic Investment
In the economic sense investment means the net additions to the economy’s capital stock which consist of goods and services. Investment in this sense implies the formation of new and productive capital in the form of new constructions, plant and machinery, inventory etc. Such investments generate physical assets.
Charecteristics of Assets:-
All investments are charecterised by certain features:
1. Return:
All investments are made with the primary objective of return. Therefore investments are characterized by the expectation of return. The return may be received in the form of yield plus capital appreciation. The dividend or interest received from investment is yield while the differences between sales price and purchase price is called capital appreciation.
2. Risk
Risk is a inherent characteristics of investment. The risk may be due to loss of capital, delay in repayment of capital, non payment of interest etc. it may be remembered that higher is the risk, higher will be the return.
3. Safety
Safety is another feature which an investors desires for his investment. It implies the certainty of return of capital without loss of money or time.
4. Liquidity
Liquidity of investment implies that the investment while is easily slable or marketable without loss of money or loss of time. Sometimes the preference shares and debuntures are not easily marketable but equity shares of companies loted in the stock exchange are easily marketable through the stock exchange.
Investment process
Investment process is generally described in for stages.
1. Investment policies:
The first stage determines and involves financial affairs and objectives before making investment. Investor has to see that he should be able to create an emergency fund, al element of liquidity and quick convertability of securities into cash. This stage may therefore be called the proper time for identifying investment assets and considering the features.
2. Investmrnt analysis
When an individual has arranged the investment he requires, the next step is the analyze the securities available for investments. He must make a comparitive analysis of type of industry, kind of security, expected return and associated risk.
3. Valuation of security
The third step is the valuation of investment. Investment values in general is taken to be the present worth to the owners of future benefit from investment. Comparison of value with current market price of the assets. Each assets must be valued on its industrial merit.
4. Portfolio constructions:
After evaluating various investment portfolio construction should be made. It requires the knowledge of different aspects of various securities.
Types of investments
1. Industrial investors:
Industrils investros have a difficult time while deterrmining their investment portfolio. They do not have usually have a time to research a share or debunture in depth before making investment decision. They have very limited time after meeting their business family and social life. The material should be locked I nto read by them must be very judiciously selected. They cannot have an extensive study. So they approach brokers, openions expressed in papers or journels or enquiry from friends engaged in business for the information to arrive at investment decision.
2. Institutional investors.
He institutional investors have both time and resources than that of individual investors. They can employ skilled economist, financial analyst and investment managers. They can purchase copies of registration documents of relevant companies and read have continuous review and scrutiny of his investment portfolio. When we adverse condition develop they can dispose of security no longer worth while. This institutional investor has a great advantage over than the average individual investor in managing his investment portfolio.
Investment V/s Speculation.
It is very difficult to make out a precise distinction between speculation and investment. An investment is a successful speculation is an unsuccessful investment. Good investment requires the ability and capacity to foresees the future events. Investment therefore requires speculation while speculation also involves some investment.
Another distinction between investment and speculation emphasize on the basis of the basic intentional of the parties while entering into business transaction. The prime objective of an investor is to get a steady flow of returns. A speculator on the other hand tends to buy an asset with the expectation of earning profit by a subsequent sale when the market rises. The speculation therefore will buy those marketable asset which he does not plan to own for a very long time.
The third distinction is that the speculation involves a higher level of risk and more uncertain expectation as compared to investment. It leads to the possibility of incurring loss in the financial transaction. In a broader sense investment is considered to involve risk and turn the capital safe.
Reference: M.Com-kerala university text
books, wekipedia.com
Sunday, March 21, 2010
Port folio analysis
Port folio simply means a group of securities held together for investment purpose. It is usual that of the investors tends to invest in a group of securities rather than single security. Individual securities have risk return characteristics of thereon. Usually the investors have an awaration of risk. It is hoped that if money is invested in several securities simultaneously. The loss in one will be compensated by the gain in others. Therefore creation of portfolio is important. This creation of portfolio is termed as diversification. The efficiency of portfolio can be evaluated only in terms of expected return and risk. Thus determining the expected risk and return of different portfolio is called portfolio analysis.
Portfolio selection
The objective of every rational investor is to maximize his return and minimize risk. Diversification is a method adopted for reducing risk. It essentially resulted in the construction of portfolio. The proper goal of portfolio construction would be to generate a portfolio that provides the highest return and lowest risk. The investor should maximize return at a given level of risk or minimize risk at a given level of return. Such a portfolio would be known as optimal portfolio. The process of finding optimal portfolio is described as portfolio selection.
*Markowitz theory
Markowitz was the first who has developed modern portfolio analysis model for portfolio construction. He generated a portfolio within a return-risk context. He considered the variance in the expected returns from investment and their relationship to each other in constructing portfolio.
Modern portfolio theory has brought out by Markowitz. It is the construction of securities to get the most efficient portfolio. A portfolio is efficient when it is expected to yield the highest relation for the level of risk accepted for a alternatively the smallest portfolio risk for a specified level of expected return. Markowitz used mathematical and statistical analysis in order to arrange for the optimum allocation of asset within portfolio.
Assumptions within Markowitz theory
1. Investors base these decision on the expected rate of return of
theirinvestment.
2. The market is efficient all investors would react all securities in the
market.
3. All investors are risk owns.
4. By combining asset the security returns are co-related to each other.
5. Investors combines the investment by getting maximum return with minimum
risk.
6. The investor can reduce his risk if he adds investments in his portfolio.
Markowitz has shown the effect combining the securities with the help of
finding out the different mathematical and statistica tools like standard
dividend., co-efficient of co-relation.
Limitations of Markowitz model
One of the major problems in this model is that a large number of input data required for the calculation. With a given set of securities infinite number of portfolio can be constructed. Because of this difficulty it found little use in practical application of portfolio analysis. Much simplification is needed and this is achieved through index models. There are essentially two types of index models.
1. Single Index Model
2. Multi Index model.
1. Single index model
It is the simplest and most widely used simplification and may be considered as the extreme point of the continuum with Markowitz model. The basic notion underlying the single index model is that all stocks are affetcetd by movements in the stock market. Casual observations in the stock prices reveals that when the market moves up prices of the most shares tempt to increase. When the market goes down response to market changes.
Sharpe Single Index Model
William Sharp tried to simplify the Markowitz method of diversification of portfolio. Sharpe index model simplifies the process of Markowitz model by reducing the data in a sustentative manner. He assumed that security not only have individual relationship but they are related to each other through some indexes represented by business activity. Sharpe has improved the estimate of expected return and variance of index which may be one or more and are related to economic activity. Sharpe index showed that the return of each securities is co-related by some securities.
2. Multi Index model.
The single index model is infact an over simplification. It assumes that stock together only because of a common movement with the market. Many researchers found that there are influences other than market that cause stock to move together. Multi index model attempts to identify and incorporate these non market factors that cause securities to move together also into the model. These extra factors are a set of economic factors that leads to changes in price. A multi index complex and require more data estimate for its application. But single index model and multi index model have helped to make portfolio analysis practical.
Portfolio selection
The objective of every rational investor is to maximize his return and minimize risk. Diversification is a method adopted for reducing risk. It essentially resulted in the construction of portfolio. The proper goal of portfolio construction would be to generate a portfolio that provides the highest return and lowest risk. The investor should maximize return at a given level of risk or minimize risk at a given level of return. Such a portfolio would be known as optimal portfolio. The process of finding optimal portfolio is described as portfolio selection.
*Markowitz theory
Markowitz was the first who has developed modern portfolio analysis model for portfolio construction. He generated a portfolio within a return-risk context. He considered the variance in the expected returns from investment and their relationship to each other in constructing portfolio.
Modern portfolio theory has brought out by Markowitz. It is the construction of securities to get the most efficient portfolio. A portfolio is efficient when it is expected to yield the highest relation for the level of risk accepted for a alternatively the smallest portfolio risk for a specified level of expected return. Markowitz used mathematical and statistical analysis in order to arrange for the optimum allocation of asset within portfolio.
Assumptions within Markowitz theory
1. Investors base these decision on the expected rate of return of
theirinvestment.
2. The market is efficient all investors would react all securities in the
market.
3. All investors are risk owns.
4. By combining asset the security returns are co-related to each other.
5. Investors combines the investment by getting maximum return with minimum
risk.
6. The investor can reduce his risk if he adds investments in his portfolio.
Markowitz has shown the effect combining the securities with the help of
finding out the different mathematical and statistica tools like standard
dividend., co-efficient of co-relation.
Limitations of Markowitz model
One of the major problems in this model is that a large number of input data required for the calculation. With a given set of securities infinite number of portfolio can be constructed. Because of this difficulty it found little use in practical application of portfolio analysis. Much simplification is needed and this is achieved through index models. There are essentially two types of index models.
1. Single Index Model
2. Multi Index model.
1. Single index model
It is the simplest and most widely used simplification and may be considered as the extreme point of the continuum with Markowitz model. The basic notion underlying the single index model is that all stocks are affetcetd by movements in the stock market. Casual observations in the stock prices reveals that when the market moves up prices of the most shares tempt to increase. When the market goes down response to market changes.
Sharpe Single Index Model
William Sharp tried to simplify the Markowitz method of diversification of portfolio. Sharpe index model simplifies the process of Markowitz model by reducing the data in a sustentative manner. He assumed that security not only have individual relationship but they are related to each other through some indexes represented by business activity. Sharpe has improved the estimate of expected return and variance of index which may be one or more and are related to economic activity. Sharpe index showed that the return of each securities is co-related by some securities.
2. Multi Index model.
The single index model is infact an over simplification. It assumes that stock together only because of a common movement with the market. Many researchers found that there are influences other than market that cause stock to move together. Multi index model attempts to identify and incorporate these non market factors that cause securities to move together also into the model. These extra factors are a set of economic factors that leads to changes in price. A multi index complex and require more data estimate for its application. But single index model and multi index model have helped to make portfolio analysis practical.
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