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Investment involves making of a sacrifice in the present with the hope of deriving future benefits. Two most important features of an investment are current sacrifice and future benefit. Investment is the sacrifice of certain present values for the uncertain future reward. It involves numerous decision such as type, mix, amount, timing, grade etc, of investment. The decision making has to be continuous as well as investment may be defined as an activity that commits funds in any financial/physical form in the present with an expectation of receiving additional return in the future.
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The expectation brings with it a probability that the quantum of return may vary from a minimum to a maximum. This possibility of variation in the actual return is known as investment risk. Thus every investment involves a return and risk. Investment has many meaning and facets. However, investment can be interpreted broadly from three angles economic, layman, financial Economic investment includes the commitment of the fund for net addition to the capital stock of the economy. The net additions to the capital stock means an increase in building equipments or inventories over the amount of equivalent goods that existed, say, one year ago at the same time. The layman uses of the term investment as any commitment of funds for a future benefit not necessarily in terms of return. For example a commitment of money to buy a new car is certainly an investment from an individual point of view. Financial investment is the commitment of funds for a future return, thus investment may be understood as an activity that commits funds in any financial or physical form in the presence of an expectation of receiving additional return in future. In the present context of portfolio management, the investment is considered to be financial investment, which imply employment of funds with the objective of realizing additional income or growth in value of investment at a future date
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Investment is concerned with the management of an investors wealth which is the sum of current income and the present value of all future incomes. In this text investment refers to financial assets. Financial investments are commitments of funds to derive income in form of interest, dividend premium, pension benefits or appreciation in the value of initial investment. Hence the purchase of shares,debentures,post office savings certificates and insurance policies all are financial investments. Such investment generates financial assets. These activities are undertaken by any one who desires a return, and is willing to accept the risk from the financial instruments
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Risk means the uncertainty in the probability distribution of returns The entire process of estimating return and risk for individual securities is known as security analysis Securities that have return and risk characteristics of their own, in combination, make up a portfolio Portfolios may or may not take on the aggregate characteristics of their individual parts Portfolio analysis takes ingredients of risk and return for individual securities and considers blending or interactive effects of combining securities Portfolio selection entails choosing the one best portfolio to suit the risk-return preferences of the investor Portfolio management is the dynamic function of evaluating and revising the portfolio in terms of stated investor objectives
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INVESTMENT vs SPECULATION
Often investment is understood as a synonym of speculation. Investment and speculation are some what different and yet similar because speculation requires an investment and investment are at lest some what speculative. Probably the best way to make a distinction between investment and speculation is by considering the role of expectation. Investments are usually made with the expectation that a certain stream of income or a certain price that has existed will not change in the future. Where as speculation are usually based on the expectation that some change will occur in future, there by resulting a return Thus an expected change is the basis for speculation but not for investment

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An investment also can be distinguished from speculation by the time horizon of the investor and often by the risk return characteristic of investment. A true investor is interested in a good and consistent rate of return for a long period of time. In contrast, the speculator seeks opportunities promising very large return earned within a short period of time due to changing environment. Speculation involves a higher level of risk and a more uncertain expectation of returns, which is not necessarily the case with investment. Speculator adds to markets liquidity and depth as he is frequently turning over his portfolio. His presence provides a market for securities (depth) and a wider distribution of ownership of securities( breadth), and enhances capital markets{ BULLS and BEARS}

Basis Type of contract Basis of acquisition Length of commitment Source of income Quantity of risk Stability of income Psychological attitude Reasons for purchase

Investment Ownership Outright purchase Long term Earnings of enterprise small Very stable Cautious &conservative Scientific analysis of intrinsic worth

Speculation Creditor Often on margin Short term Changes in market price large Uncertain &erratic Daring &careless On tips, hunches, inside dope etc.
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Characteristics of Investment ` The characteristics of investment can be understood in terms of as - return, - risk, - safety, - liquidity etc. ` Return: All investments are characterized by the expectation of a return. ` In fact, investments are made with the primary objective of deriving return. ` The expectation of a return may be from income (yield) as well as through capital appreciation. ` Capital appreciation is the difference between the sale price and the purchase price. ` The expectation of return from an investment depends upon the nature of investment, maturity period, market demand and so on.
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Risk: Risk is inherent in any investment. Risk may relate to loss of capital, delay in repayment of capital, nonpayment of return or variability of returns. The risk of an investment is determined by the investments, maturity period, repayment capacity, nature of return commitment and so on. Risk and expected return of an investment are related. Theoretically, the higher the risk, higher is the expected returned. The higher return is a compensation expected by investors for their willingness to bear the higher risk.

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Safety: The safety of investment is identified with the certainty of return of capital without loss of time or money. Safety is another feature that an investordesires from investments. Every investor expects to get back the initial capital on maturity without loss and without delay. Liquidity: An investment that is easily saleable without loss of money or time is said to be liquid. A well developed secondary market for security increase the liquidity of the investment. An investor tends to prefer maximization of expected return, minimization of risk, safety of funds and liquidity of investment.

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INVESTMENT PROCESS: Given the foundation for making investment decisions the trade off between expected return and risk- we next consider the decision process in investments as it is typically practiced today This is a two step process- Security Analysis and Portfolio Management Security analysis involves the valuation of securities Portfolio management involves the management of an investors investment selections as a portfolio (package of assets), with its own unique characteristics.

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Security Analysis Traditional investment analysis, when applied to securities, emphasizes the projection of prices and dividends. That is, the potential price of a firms common stock and the future dividend stream are forecasted, then discounted back to the present. This intrinsic value is then compared with the securitys current market price. If the current market price is below the intrinsic value, a purchase is recommended, and if vice versa is the case sale is recommended. Although modern security analysis is deeply rooted in the fundamental concepts just outlined, the emphasis has shifted. The more modern approach to common stock analysis emphasizes return and risk estimates rather than mere price and dividend estimates

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Portfolio Management Portfolios are combinations of assets. In this text, portfolios consist of collections of securities. Traditional portfolio planning emphasizes on the character and the risk bearing capacity of the investor. For example, a young, aggressive, single adult would be advised to buy stocks in newer, dynamic, rapidly growing firms. A retired person/widow would be advised to purchase stocks and bonds in old-line, established, stable firms, such as utilities. Modern portfolio theory suggests that the traditional approach to portfolio analysis, selection, and management may yield less than optimum results. Hence a more scientific approach is needed, based on estimates of risk and return of the portfolio and the attitudes of the investor toward a riskreturn trade-off stemming from the analysis of the individual securities.

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INVESTMENT CATEGORIES: Investment generally involves commitment of funds in two types of assets: -Real assets,Financial assets Real assets: Real assets are tangible material things like building, automobiles, land, gold etc. Financial assets: Financial assets are piece of paper representing an indirect claim to real assets held by some one else. These pieces of paper represent debt or equity commitment in the form of IOUs or stock certificates. Investments in financial assets consist of -Securitiesed (i.e. security forms of) investment - Non-securities investment

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The term securities used in the broadest sense, consists of those papers which are quoted and are transferable. ` Under section 2 (h) of the Securities Contract (Regulation) Act, 1956 (SCRA) securities include: i) Shares, bonds, debentures,or other marketable securities of a like nature in or of any incorporated company or other body corporate. ` ii) Government securities ` iii) Such other instruments as may be declared by the central Government as securities, and, ` iv) Rights of interests in securities. ` Therefore, in the above context, security forms of investments include Equity shares, preference shares, debentures, government bonds, Units of UTI and other Mutual Funds, and equity shares and bonds of Public Sector Undertakings (PSUs)
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Non-security forms of investments include all those investments, which are not quoted in any stock market and are not freely marketable. viz., bank deposits, corporate deposits, post office deposits, National Savings and other small savings certificates and schemes, provident funds, and insurance policies. Another popular investment in physical assets such as Gold, Silver, Diamonds, Real estate, Antiques etc. The investor has to choose proper avenues from among them, depending on his specific need, risk preference, and return expectation. Investment avenues can be broadly categorized under the following heads: 1.Corporate securities Equityshares ,DebenturesBonds ,Warrants,Preference shares,GDRs /ADRs,Derivatives 2.Deposits in banks and non banking companies 3.Post office deposits and certificates 4.Life insurance policies 5.Provident fund schemes 6.Government and semi government securities 7.Mutual fund schemes 8.Real assets

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Equity Shares: Blue chips, Growth stocks, Income stocks, cyclical stocks, discount stocks, under valued stocks, turn-around stocks Preference Shares Debentures and bonds GDR/ADR Warrants:It can be defined as a long-term call option issued by a company on its shares. Derivatives: Futures, Options Deposits: Savings, Fixed, Cumulative, Recurring Company Fixed Deposits Post office deposits and certificates Life Insurance Policies PF schemes, ELSS, Government and semi-government securities and MF Schemes REAL ASSETS: Real estate, Bullion schemes

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Return and Risk: Underlying all investment decisions is the trade off between expected return and risk. Return:In investments it is critical to distinguish between an expected return (the anticipated return for some future period) and a realized return (the actual return over some past period). Measuring Return:Measurement of return occupies a strategic importance in investment analysis as the investment is undertaken with a view to get returns in future
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Total Return:A correct returns measure must incorporate the two components of return, yield and price changes TR = { any cash payments received +price changes over the period}/price at which the asset is purchased TR = {CFt+ (Pe Pb)}/Pb Two measures while estimating total returns over a period are Arithmetic mean and geometric mean Arithmetic mean: X (avg.) =Sum X/n or sum of each value of X divided by number of observations, n Geometric mean : is needed to describe accurately the true average rate of return over multiple periods

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Geometric Mean: to understand this we should know RR (Return relative) This is particularly true when calculating a geometric mean because negative returns cannot be used in the calculation RR( Return relative) = TR in decimal form +1.00 Although return relatives may be less than 1.0, they will be greater than zero, thereby eliminating negative numbers

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Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

SensexTRs(%) -3.14 30.00 30.00 9.94 1.29 37.11 22.68 33.10 28.34 20.88

Sensex RR 0.9687 1.30001 1.30001 1.09942 1.01286 1.37113 1.22683 1.33101 1.28338 1.20880

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Calculation of the Arithmetic and Geometric mean for the years 1996-2005 for the Sensex Stock Composite Index using the above table Arithmetic mean = [-3.14 + 30.00 +.... + 20.88]/10 = 18.76% Geometric mean = [(0.9687) (1.30001)(1.30001)(1.09942)... (1.2088)]^(1/10)- 1 = 1.18 - 1 = 0.18, or 18% The geometric mean returns measure the compound rate of growth over time. It is often used in investments and finance to reflect the steady growth rate of invested funds over some past period G = [(1+TR1)(1+TR2).... (1+TRn)]^1/n 1 Where TR is a series of total returns in decimal form

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RISK: Sources of Risk: Risk is explained theoretically as the fluctuation in returns from a security. A security that yields consistent returns over a period of time istermed as risk less security or risk free security When one invest, expects some particular return, but there is a risk that he ends up with a different return when he terminates the investment. The more the difference between the expected and the actual the more is the risk Factors influence risk: What makes financial assets risky. Several factors causing risk such as business failure, market fluctuations, change in the interest rate,inflation in the economy, fluctuations in exchange rate,changes in the political situation etc.

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