Introduction to Investment

Chapter 1

Why Do Individuals Invest ?

By saving money (instead of spending it), individuals
forego consumption today in return for a larger
consumption tomorrow.

How Do We Measure The Rate Of

Return On An Investment ?
The real rate of interest is the exchange rate between
future consumption (future dollars) and present
consumption (current dollars). Market forces
determine this rate.
Tomorrow
$104

If you are willing to exchange a

certain payment of $100 today
for a certain payment of $104
tomorrow, then the pure or real
rate of interest is 4%

$100

Today

How Do We Measure The Rate Of

Return On An Investment ?
If the purchasing power of the future payment will
be diminished in value due to inflation, an investor
will demand an inflation premium to compensate
them for the expected loss of purchasing power.
If the future payment from the investment is not
certain, an investor will demand a risk premium to
compensate for the investment risk.

Defining an Investment
Any investment involves a current commitment of
funds for some period of time in order to derive
future payments that will compensate for:
the time the funds are committed (the real rate of return)
the expected rate of inflation (inflation premium)
uncertainty of future flow of funds (risk premium)

Investment Objectives

Short Term high priority objectives

Long Term high priority objectives
Low priority objectives
Money making objectives

Expectation from Investment

Lifestyle
Financial Security
Return
Value for Money
Peace of Mind

Elements of Investment

Return
Risk
Time
Liquidity
Tax Savings

Investment Alternatives

Shares
Debentures and Bonds
Public Deposits
Bank Deposits
Post Office Savings
Public Provident Fund (PPF)
Money Market Instrument

Contd.

Mutual Fund Schemes

Life Insurance Schemes
Real Estates
Gold-Silver
Derivative Instruments
Commodity Market (commodities)

The Investment Process

Five steps:
Set investment policy
Perform security analysis
Construct a portfolio
Revise the portfolio
Evaluate performance

STEP 1: Investment Policy

Identify investors unique objective
Determine amount of investable wealth
State objectives in terms of risk and return
Identify potential investment categories

Step 2: Security Analysis

Using potential investment categories,
find mispriced securities
Using fundamental analysis
Intrinsic value should equal discounted present value

Compare current market price to true market value

Identify undervalued securities

Step 3: Construct a Portfolio

Identify specific assets and proportion of wealth in
which to invest
Address issues of
Selectivity
Timing
Diversification

Step 4: Portfolio Revision

Periodically repeat step 3
Revise if necessary
Increase/decrease existing securities
Delete some securities
Add new securities

Step 5: Portfolio Performance

Evaluation
Involves periodic determination of portfolio
performance with respect to risk and return
Requires appropriate measures of risk and return