SH1663

Investments
I. Types of Investment
A. Types of Investment
o Stocks – When a person buys stocks, s/he becomes an owner of the business. Stocks are
sold and bought at a stock market. If the company makes money, the stockholder may be
paid a share of the profit, called dividends. Capital appreciation happens when the current
market price of the investment of the stock is higher than its purchase price, allowing the
investor to earn money. Cash dividend payment happens when the business pays out a
portion of its earnings to its stockholders.
o Bonds – When a person buys a bond, the individual loans money to an entity and this entity
pays the individual back over a set period of time. A bond is a security that represents the
debt of a government or a business, promising to pay a fixed interest to the holder of the
bond for a definite period of time. Bonds are prioritized over stocks. Bondholders are
guaranteed that they will get their money back, plus regular interest payment called
coupons. Bonds that sell above its face value (the borrowed amount) are said to be selling
at a premium, while those that are selling below face value are said to be selling at a
discount.
o Managed funds – A managed fund is a type of managed investment scheme. In a managed
fund, an investor’s money is pooled with other investors. An investment manager then buys
or sells shares or other assets on the investors’ behalf. Investors are usually paid income or
distributions periodically, and the value of the investment will rise or fall with the value of
the underlying assets. The investment manager may be called a ‘Fund Manager’ or
‘Responsible Entity’.
In the Philippines, managed funds can be either mutual funds or Unit Investment Trust
Fund (UITF). A mutual fund is classified as a corporation and is regulated by Philippine
Securities and Exchange Commission (SEC). An investor in a mutual fund is buying shares
of that mutual fund and is considered a stockholder. The mutual funds investor is therefore
entitled to the same rights as a shareholder of ordinary companies. On the other hand, a
UITF is a trust fund and therefore subject to strict regulations by the Bangko Sentral ng
Pilipinas (BSP). They are sold mostly by banks. An investor in UITF is buying units of
participation in the fund and is not considered as a stockholder. Both mutual funds and
UITF’s are further classified as:
 Equity fund – These managed funds invest mainly in stocks.
 Bond fund/ Fixed-income fund and income fund – These managed funds invest
primarily in bonds.
 Balanced fund – These managed funds combine stocks and bonds.
 Money market fund – These managed funds invest primarily in short-term securities
representing liquid debt and monetary instruments.
o Real estate – Those who invest in real estate may be considered more traditional than other
types of investors. Real estate investing is a broad category of operating, investing, and
financial activities focused on making money from tangible property. The general purpose
of invested real estate is for income, rather than for residence. Real estate investors may use

12 Handout 1 *Property of STI

Page 1 of 3
 SH1663

these properties to sell rent or trade them when the prices appreciate. There are several
benefits to investing in real estate:
 Hedge against inflation – Real estate prices increase over time. Inflation causes prices
of goods to go up, which means that buyers can purchase less than what they did before.
If an individual has real estate investments, he or she may be assured that the value of
the properties will increase over time and can cover the expenses he/she has incurred.
 Rent income – Real estate investments may provide regular rent income or cash flows.
 Debt payment – Real estate are considered as tangible properties, which can be sold to
pay off debts of the investor or debts of the business.
There are also some disadvantages in real estate investment:
 Illiquid investments – Real estate cannot be easily convertible to cash. It may take a long
time to sell a property, and their conversion to cash may limit the investor. While these
assets are not yet liquidated, the interest on the investor’s debts are increasing.
 Deflation – Deflation occurs when the prices go down instead of up. This would mean
that a real estate investor will be forced to sell his/her properties for less than he/she
initially acquired it for.
 Lack of diversification – Real estate investments are expensive, so individuals can only
invest in one (1) or two (2) properties. This means that the investor loses his opportunity
to invest in other types of investments or securities that offer better features.
 Management and operating expenses – An investor would usually incur more costs in
managing real estate than any of the other investments. The real estate investor would
need to look for reliable tenants and maintain the property, which is not needed in other
investments.
II. Managing Risks
A. Concepts in Risk and Return
• Risk exists when there is no certainty about the outcomes that an investment will produce.
It is the chance of financial loss or the variability of returns with a given asset.
• Return is the financial outcome of an investment. It can also refer to the total gain or loss
experienced on an investment over a given period of time.
• A way of indicating the risk and uncertainty relating to a proposed decision is to estimate
a range of outcomes. Firms would determine the best, worst, and most likely outcome. This
is sometimes called three-level analysis.

B. Measuring Risk
• Risk is present whenever businesses are not certain how much they will earn for their
investments. However, if they have enough information, they can create a probability
distribution or a list of possible returns and the corresponding probability of occurrence.
Let us consider the investment in the table.
Return, 𝑅𝑅1 Probability, 𝑃𝑃1
1.50 10%
2.00 20%
2.50 40%
3.00 30%

12 Handout 1 *Property of STI

Page 2 of 3
 SH1663

• We can also use a formula to determine the expected return. Expected return E(R) can be
calculated as:
𝐸𝐸(𝑅𝑅) = 𝑅𝑅1 𝑃𝑃1 + 𝑅𝑅2 𝑃𝑃2 + ⋯ 𝑅𝑅𝑛𝑛 𝑃𝑃𝑛𝑛
• To measure the variability of outcomes, the standard deviation (𝜎𝜎) is used. The standard
deviation is an expression of dispersion around the expected value. To compute the
standard deviation, we use the formula:
𝜎𝜎 = �∑𝑛𝑛𝑖𝑖=1 (𝑅𝑅𝑖𝑖 − 𝑅𝑅� )2 (𝑃𝑃𝑖𝑖 )
Where:
𝑅𝑅1 = the return
𝑅𝑅� = the expected average return, and
𝑃𝑃𝐼𝐼 = the probability of each return.

C. Managing risk
• Given the risk-return tradeoff, it is important for businesses to know how to manage their
investment risk. Some strategies in managing risk are:
o Following the trend – One (1) way to manage investment risk is to commit to only
buying stocks with an upward trend and to sell them once they break their pattern.
o Position sizing – Another way to manage risks is limiting exposure. If a given
investment is riskier than others, the business can choose not to invest in it or to invest
only a small amount of capital.
o Diversification – The idea behind investment diversification is to buy asset classes or
stocks that are negatively correlated. A negative correlation exists between two (2)
investments if one (1) investment increases while the other decreases. If a business
chooses to invest in these types of businesses, they will always earn something.
However, it is almost impossible to have a portfolio with all assets that are perfectly
negatively correlated. Businesses would, therefore, create a combination of assets that
would reduce the risk of loss.

References:
A list of the different types of investments. (n.d.). Retrieved from The Money One Website: http://themoney.one/different-types-of-investments/
Basics of investments - financial concepts. (n.d.). Retrieved from HSBC Global Asset Management Website: http://www.assetmanagement.hsbc.com/in/mutual-
funds/learning-centre/investment-basic/fin_concepts.html
Benito, P. P., Chan Pao, T. P., & Yumang, K. (2016). Exploring small business and personal finance in senior high. Quezon City: Phoenix Publishing House.
Definition of 'risk-return trade-off'. (n.d.). Retrieved from Economic Times Website: http://economictimes.indiatimes.com/definition/risk-return-trade-off
Financial concepts: The risk/return tradeoff. (n.d.). Retrieved from Investopedia Website: http://www.investopedia.com/university/concepts/concepts1.asp
Investing 101: Types of investments. (n.d.). Retrieved from Investopedia Website: http://www.investopedia.com/university/beginner/beginner5.asp
Investment. (n.d.). Retrieved from Investopedia Website: http://www.investopedia.com/terms/i/investment.asp
Investment real estate. (n.d.). Retrieved from Investopedia Website: http://www.investopedia.com/terms/i/investmentrealestate.asp
Kennon, J. (2016). How to invest in real estate. Retrieved from The Balance Website: https://www.thebalance.com/how-to-invest-in-real-estate-357989
Kofman, P., & Pinder, S. (n.d.). Alternative attitudes towards risk (I don't hate risk, I'm just averse to it...). Retrieved from Coursera Website:
https://www.coursera.org/learn/valuation/lecture/fQXlg/1-2-alternative-attitudes-towards-risk-i-don-t-hate-risk-i-m-just-averse-to-it
Lamb, K. (n.d.). Measuring and managing investment risk. Retrieved from Investopedia Website: http://www.investopedia.com/articles/08/risk.asp
Managed funds. (2016). Retrieved from Australian Securities and Investments Commission Website: https://www.moneysmart.gov.au/investing/managed-funds
Real estate investing: A guide. (2017). Retrieved from Investopedia Website: http://www.investopedia.com/mortgage/real-estate-investing-guide/
The reality of investment risk. (n.d.). Retrieved from Financial Industry Regulatory Authority Website: http://www.finra.org/investors/reality-investment-risk
Vanguard. (2015). Investment fundamentals an introduction to the basic concepts of investing. Retrieved from Vanguard Website:
https://www.vanguard.co.uk/documents/adv/literature/client_material/investment-fundamentals-guide.pdf
Wong, K. (2015). The many different types of investments, and how they work. Retrieved from Two Cents Website: http://twocents.lifehacker.com/the-many-different-types-
of-investments-and-how-they-w-1683582510

12 Handout 1 *Property of STI

Page 3 of 3