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Investment Speculation
1. Risk and Return
Earning a good ROR for an Willing to take high risk in exchange for
appropriate level of risk a high ROR by buying very volatile
stocks.
2. Time Horizon
Hold securities for a longer period Interested in seeking opportunities over a
of time. At least 1 year short period of time. Few days, weeks or
months.
3. Performance
Interested in a company with a Interested in a less consistent
consistent performance performance along with some abnormal
and extremely ROR.
4. Motivation
Investor is more concerned with Speculators are more concerned with
dividend payments & com long rapid short term price appreciation.
term growth prospect
5. Decisions and Funds to buy 5. Decisions and Funds to buy
Careful & thorough fundamental Speculators will buy securities using
analysis in terms of past borrowed funds and choose securities
performance and future prospects. mostly based on intuition and rumors
Normally use their own money to spread in the market.
buy securities
Investment Gambling
1. Purpose
A way of earning an income Is a form of entertainment
2. Time Horizon
Hold securities for a longer period A gamble is over when a dice is rolled or
of time. At least 1 year a card is turned. Short period of time
2.
FINANCIAL
OBJECTIVES Liquidity of Financial Management
portfolios Constraint Constraint
Portfolio
diversification
Stability in
income Psychological
Protection
Safety of Constraint
against
principal
inflation
TYPES OF INVESTMENT
(a) Securities and property are simply two classes of investments. Securities are
investments, commonly evidenced by certificates, which represent a legal claim. For example, a
bond represents a legal claim on debt, and a stock represents a proportionate ownership in the
firm. An option, on the other hand, represents the legal right to either buy or sell an asset at a
predetermined price within a specified time period. Property constitutes investments in either
real property (land and buildings) or tangible personal property (paintings, vases, or antique
cars).
(b) 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.
(c) An investment in debt represents funds loaned in exchange for the receipt of interest income
and repayment of the loan at a given future date. The bond, a common debt instrument, pays
specified interest over a specified time period, then repays the face value of the loan. An equity
investment provides an investor an ongoing fractional ownership interest in a firm. The most
common example is an investment in a company’s common stock. Derivative securities are
securities derived from debt or equity securities and structured to exhibit characteristics
different from the underlying 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.
(d) Short-term investments typically mature within one year while long-term investments have
longer maturities, including common stock, which has no maturity at all. However, long-term
investments can be used to satisfy short-term financial goals.
INVESTMENT GOALS
(b) Saving for major expenditures includes money set aside for such things as the down payment
on a home, college tuition, and even an expensive vacation. The amount of money needed and
the time period over which one can save will determine the amount set aside and, frequently,
the investment vehicle employed.
(c) The single most important reason for investing is to accumulate retirement funds. The amount
that must be set aside is determined by the level of expected expenditures, expected income
from social security and other sources, and the amount of interest expected to be earned on
savings.
(d) Sheltering income from taxes involves taking advantage of certain tax provisions that permit
reduction of the income reported to the government or direct reductions in taxes. Investments in
certain assets, such as real estate, may be attractive due to their tax advantages.
STEPS TO INVESTMENT
INVESTMENT CONSTRAINTS
2. Psychological Constraints: refers to how well an investor can absorb the consequences
of an investment decision. Emotions like greed, fear, caution and hope will be a vital part in any
investment decision. If investors cannot control their emotion, they might end up wrong and
costly investment decision.
Definition:
In finance, risk refers to the chance that the return from an investment will differ from its expected
value. The broader the range of possible values (dispersion), the greater the risk of the investment.
Low-risk investments are those considered safe with respect to the return of funds invested and the
receipt of a positive rate of return. High-risk investments are those which have more uncertain
future values and levels of earnings.
Return: the future value amount that can get from an investment activity (reward)
Example: if Mr. X expect to get a return of 15% out of an investment but the actual return turns out
to be 10%, then the 5% difference reflect the risk involves in that particular investment.
TYPES OF RISK
TOTAL RISK
2. Market Risk
Refers to the possibility of loss due to fluctuations in stock prices. The prices of a stock
go up and down due to the investors’ reaction to both tangible and intangible events.
Tangible events: political, social, economic factors
Intangible events: related to the market psychology.
How to hedge:
Carefully examine
Good at the timing
Hold stocks for a relatively long period.
UNSYSTEMATIC RISK
Unsystematic risks are risks that are unique to a firm or an industry. It is associated with random
causes that can be eliminated through diversification.
Factors such as regulatory action, mismanagement of a firm, labor difficulties, consumer
preferences, loss of key account and labor strike are sources of unsystematic risk.
For example, only the stock price of Tenaga Nasional will affected by the news of a major
explosion in the Tenaga Nasional power plant. The price of other unrelated stocks shouldn’t be
affected since the factor contributing to unsystematic risk only affects one firm.
1. Business Risk
Related to the operating environment of the business. Maybe because of internal or
external factors.
External factors: operating conditions imposed upon the firm by circumstances beyond its
control such as business cycle.
Internal factors: how efficient the company conducts its business
How to reduce:
1. Good management team
2. Diversification
2. Financial Risk
Refers to how a firm finances its activities. Investors will look at the firm’s capital
structure. Investors are concerned whether the company is heavily financed by fixed-payment
intstruments such as debt and preferred stocks.
How to reduce:
How to finance
ER
Return
Y1
0 X
Risk
1. Risk averse
Conservative type. They require an additional expected return to compensate for
accepting an increase in risk. This type of investors will make sure that they will get a
return for each dollar they put in an investment.
2. Risk taker
Aggressive type. Investors who are willing to accept a large amount of risk for relatively
small increase in the expected return.
3. Risk neutral
Moderate type. Investors who would be satisfied if they will get only the principal that
they put in the investment.