Understanding of Investment&

Speculation

Investment Definitions

• Investment: An investment is the current commitment of money or other resources in the expectation of reaping future benefits. (Kane, Bodie and Marcus 2005)

Speculation: Act of trading in an asset, or conducting transaction, that has significant risk of losing most or all of initial outlay, in expectation of substantial gain.

Speculation Definitions

Definitions

Generally, “investments” refers to financial assets and in particular to marketable securities.

Financial assets are paper or electronic claims on some issuer, such as the government or a company.

Marketable securities financial assets that are easily and cheaply tradable in organized markets

Real assets are tangible assets such as gold, silver, diamonds, real estate.

Investment

• Long term planning (at least one year)

• Low or moderate risk.

• Low or moderate rate of return.

• Investment decisions are based on fundamentals.

• Investors leveraged its own funds.

Speculation

• Short term Planning (few days or months)

• High Risk.

• High rate of return.

• Decisions are based on hearsay and market psychology.

• Resort to borrowed funds.

If we do not invest, then?

If we have savings and we do not invest, we can’t earn anything on our savings.

Second, the purchasing power of cash diminishes in inflation

This means that if savers do not invest their savings, they will not only lose possible return on their savings, but will also lose value of their money due to inflation

If we do not invest, then?

The expected risk-return trade-off

Steps in the decision process

• Traditionally, the investment decision process has been structured using two-steps:– Security analysis– Portfolio management

Security Analysis

Security analysis: this is the first part of investment decision process

It involves the analysis and valuation of individual securities

To analyze securities, it is important to understand the characteristics of the various securities and the factors that affect them

Then valuation model is applied to find out their value or price

Security Analysis

Value of a security is a function of estimated future earnings from the security and the risk attached

For securities valuation, investors must deal with economy, industry or the individual company

Both the expected return and risk must be estimated keeping in view the economic, market or company related factors

Portfolio Management

The second major component of the decision processes is portfolio management

After securities have been analyzed and valued, portfolio of selected securities is made

Once a portfolio is made, it is managed with the passage of time

For management, there can be two approaches

Portfolio Management

Approaches to portfolio management:◦ A. Passive investment strategy

◦ B. Active investment strategy

In Passive Strategy, investors make few changes in the portfolio so that transactions costs, time and search costs are minimum

In Active Strategy, investors believe that they can earn better returns by actively making changes in the portfolio