DEFINING INVESTMENT 1.

In finance, the purchase of a financial product or other item of value with an expectation of favorable future returns. In general terms, investment means the use money in the hope of making more money. The dictionary meaning of investment is to commit money in order to earn a financial return or to make use of the money for future benefits or advantages. People commit money to investments with an expectation to increase their future wealth by investing money to spend in future years. For example, if you invest Rs. 1000 today and earn 10 %over the next year, you will have Rs.1100 one year from today. Investment benefits both economy and the society. It is an outgrowth of economic development and the maturation of modern capitalism. For the economy as a whole, aggregate investment sanctioned in the current period is a major factor in determining aggregate demand and, hence, the level of employment. In the long term, current investment determines the economys future productive capacity and, ultimately, a growth in the standard of living. By increasing personal wealth, investing can contribute to higher overall economic growth and prosperity. The process of investing helps to create financial markets where companies can raise capital. This too, contributes to greater economic growth and prosperity. Specific types of investments provide other benefits to society as well. For instance, common stocks provide a mechanism for stockholders to monitor the performance of company management. At the same time, municipal bonds provide capital for valuable public projects such as schools and roads. Although, the rewards of investing are obvious, investing is not without risk. However, over the long run, the rewards of investing outweigh the risks. Investment teaches how we can use our accumulated assets to earn a monetary return instead of waiting to spend those assets on consumption. Thus investment can be defined as the purchase of an asset to produce a return. Therefore, before investing, one must accumulate some assets, which is done through the process of saving, or spending less than our incomes. This applies to all financial entities, be it a household, business or a unit of government. Assets that are accumulated by saving may or may not earn a return. However, the overall return that an investor may realize depends upon a number of things such as amount of money available for investment; the degree of risk that the investor is willing to take; the amount of immediate income that is needed; the degree of liquidity that is required; the intelligence and knowledge that the investor processes; and sheer luck. An investment is a commitment of funds made in the expectation of some positive rate of return. If the investment is done properly, the return will be commensurate with the risk the investor assumes. It is the employment of funds with the aim of achieving additional income. It involves the commitment of resources, which have been saved away from current consumption in the hope that some benefit will accrue in future.

Investment involves the use of current funds of a purpose other than to satisfy the immediate consumption need of the owner. Therefore, the application of money to a purpose , which does not involve immediate use on the part of the owner, is known as investment of money. It is an operation that involves the transfer of money or title to money into the hands of others, who in return, agree to return them with interest or dividend. OBJECTIVES OF INVESTMENT Investment is the sacrifice of certain present value for uncertain future reward. All investment choices are made at points of time in accordance with the personal investment ends and in contemplation of an uncertain future. Since investments in securities are revocable, investment ends are transient and the investment environment is fluid. As one conceives of the distant future, the reliable bases for reasoned expectations become more and more vague. Investors in securities should, therefore, reappraise and re-evaluate their various investment commitments from time to time, in the light of new information and changed expectations. Investment helps in arriving at numerous decisions that are not only continuous but rational too. Investment decisions are found to be the outcome of three different but related classes of factors: 1. Informational or Factual premises: The investor is provided with many streams of data that are taken together and represent the observable environment as well as the features of the securities and firms in which he may invest. 2. Expectational Premises: Various environmental and financial facts are made available to the investors that spark a light of expectations relating to the outcomes of alternative investments though they are subjective and hypothetical. This not only limits the range of investments, which may be undertaken but also the expectations of outcomes that may legitimately be entertained. 3. Valuational Premises: These comprise the structure of subjective preferences for the size and consistency of the income to be received and for the safety and negotiability of various investments as these are appraised from time to time. THE INVESTMENT PROCESS Viewing investment as a process, which goes on in every society, one may ask exactly what that process consists of and what limits it. The investment process is a complex activity that describes the steps of decision-making followed by an investor regarding the appropriate time to invest in. Traditionally, securities are analyzed and managed using a broad two-step process - Security

analyses and Portfolio management. This two-step process may be broken down into the following steps: 1. Setting Investment Policy: The initial step of the investment process involves specification of investment objectives, investment constraints, determination of invest-able wealth, identification of potential investment assets, tax status of the investor, considering attributes of investment assets. Investment objectives should be stated in terms of both risk and return. In other words, the objective of an investor is to make a lot of money accepting the fact losses may be incurred. The typical objectives of investors are current income, capital appreciation, and safety of principal. Moreover, constraints arising due to liquidity, the time horizon, tax and other special circumstances, if any, must be identified. This step of investment process also identifies the potential financial assets that may be included in the portfolio basing on the investment objectives, amount of investable wealth and tax status of the investor. 2. Asset-mix decision An investor has to decide the proportions of stocks and bonds to be included in the portfolio. An appropriate stock-bond mix depends mainly on the risk tolerance nature of the investor. 3. Formulation of portfolio strategy After the choice of asset mix, the very next step is to formulate an appropriate portfolio strategy. Broadly, there are two choices available an active portfolio strategy and a passive portfolio strategy. An active portfolio strategy focuses primarily on earning superior risk adjusted returns. This strategy seeks to change the proportions chosen in the asset-mix expecting to earn more profit. While, a passive portfolio strategy involves holding a diversified portfolio that maintains a predetermined legal risk. This strategy determines the desired investment proportions and assets in a portfolio and maintains these, making a few changes over time, if necessary. 4. Perform Security analysis This step involves valuation and analysis of the securities available for investment regarding their future behaviour, expected return and associated risk. For valuation of securities., first of all, it is necessary to understand the characteristics of the various securities to estimate their. Secondly, a valuation model is to be applied to these securities to estimate their value (or price). The relative attractiveness of the security can be determined by comparing the estimated value with the current market price of the security. Basically, there are two approaches to security analysis Technical Analysis and Fundamental analysis. Technical Analysis involves the study of stock market prices of a firm in order to predict the future price movements. By identifying an emerging trend or

pattern in rice movements of a stock, the technical analyst hopes to predict accurately the future price movements of that particular stock. On the other hand, fundamental analysts, past price movements have no effect on the future prices of a stock. They say that the intrinsic (or true) value of an asset is equal to the present value of cash flows or earnings that the asset holder is expected to receive. To determine the intrinsic value of an equity stock, the security analyst must forecast the earnings and dividends expected from the stock and then convert to their equivalent present value by using an appropriate discount rate that reflects the riskiness of the stock. Once the intrinsic value of the common stock has been determined, it is compared to the current market price of the stock. Stocks that have an intrinsic value more than the current market price are said to be under-valued or under priced and should be purchased whereas those that have an intrinsic value less than the current market price are said to be over-valued or over Priced and should be sold out. However, fundamental analysts believe that the market will correct this mis-pricing of securities in future. In other words, undervalued stock prices will show unusual appreciation where as prices of overvalued stock will show unusual depreciation. 5. Portfolio construction and execution After securities have been evaluated, the next step is construction and execution of the portfolio. This is the phase that is concerned with the implementation of portfolio strategy. This involves identification of the specific assets in which the investor should invest and determination of the proportions of investors wealth to be invested in each of the assets. An investor makes two types of decisions while constructing portfolios the asset allocation decision and the security selection decision. The asset allocation decision is the choice among broad asset classes, while the security selection decision is the choice of particular securities to be held within each asset classes. Accordingly there are two approaches to portfolio construction top down and bottom up. Top down portfolio construction starts with asset allocation and only after that, the investor decides on the particular securities to be held. On the other hand, in the bottom up approach, the portfolio is constructed from the securities that appear to be attractively priced without concerning about asset allocation. Thus, the main features of portfolio construction and execution are determination of diversification level, consideration of investment timing, selection of investment assets and allocation of invest-able wealth to investment assets.

Example of Investment Portfolio Cash 10 Income Stocks 20

Growth Stocks 38 Treasury Bills 17 Corporate Bonds15

Cash

Income Stocks

Growth Stocks

Treasury Bills

Corporate Bonds

6. Portfolio Revision Having built a portfolio, an investor must consider when and how to revise it. Portfolio revision involves the periodic repetition of the above steps. The investment objectives of an investor may change over time and the current portfolio may no longer be optimal for him. So the investor may form a new portfolio by selling certain securities and purchasing others that are not held in the current portfolio. Moreover, the value of a portfolio as well as its composition (i.e. the relative proportions of stock and bond components) may change over time as stocks and bonds tend to fluctuate. As a result, some securities that were not attractive initially may become attractive and vice- versa. In response to such changes, the investors may like to revise and rebalance his existing portfolio. 7. Performance Evaluation The final step in the investment process is the performance evaluation of the portfolio. Investments are always made under conditions of uncertainty and it is necessary to evaluate periodically how the investment (portfolio) performed so that, if necessary, the investor may consider switching over to alternate proposals. The performance of evaluation of a portfolio is done in terms of risk and return. The key issue is whether the portfolio return is commensurate with its risk exposure. This may provide useful feedback to improve the quality of the portfolio management process.