CHAPTER 1
INTRODUCTION
TO INVESTMENT
Introduction
Definition of
Investment
The Differences
between Investment Concept and Speculations
Financial System’s
Users
1.0 INTRODUCTION
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In general, investment may be referred to the ownerships of
physical and financial assets.The physical assets may consist of investment and
ownership of property (including buildings), machinery, technology and any
forms of visible sources. Meanwhile, financial assets are comprised of shares,
bonds, trade notes’ ownership and other ownership of financial assets.
Although we tend to measure the wealth of economy by referring to
the capacity of national production, infrastructure development, services andsophisticated
technology wealth, where all of these are focused on physical assets. However, indirectly, it cannot be denied that
the financial assets also make a contribution in physical assets existing. For example, in the establishment of a
national car production, require a large allocation of funds to finance the
project. Therefore,
companies should consider the alternatives whether using existing capital
provision, issuing new shares, issuing bonds or by using financial instruments
available in the market. This shows that financial assets play a significant
role in the existence of visible assets.
In addition, financial assets will
also allow the distribution of wealth and profits in the economy became more
extensive and not confined to certain groups. Most of us may not be able to have their own car factory; hence, we
can still enjoy the benefits and take part in business activities if we own the
shares in that car company. This example shows that the existence
of financial assets not only helps the existence of physical assets, also
giving space and opportunity to individuals in the economy to enjoy the
benefits from whichever industry they are invested in.
1.1
DEFINITION OF INVESTMENT
Investment is the commitment of financial resources that we have
today hoping to gain profit/benefit in the near future. Investment can occur by managing systematically
and making decision based on specific analysis on the financial assets or
physical assets.
Investors are advised to make a wise decision in making an
assessment of risks and returns on investment that may be encountered by them.
Return or profit on the investment may consist of dividends,
capital gains or interest (financial assets) and cost of an asset. In other
words, investment is an activity for earning the future profits or increased in
future value of money based on the current monetary value.
Most people are actually involved with an investment during their life;
we will make savings to enable us to withdraw money in the near future or
during emergencies. We also may purchase houses or land hoping in the future we
can sell them at a higher price. If you are interested in the equity markets,
you may consider of buying shares of companies that have the potential to grow,
and will sell the shares back after reaching your desired price. Or, you may consider
of buying insurance or make a deposit in savings account hoping that the money
will grow and can be used after your retirement. Mention above is some examples
of good investment in real assets and financial assets.
1.2
INVESTMENT VS SPECULATION
If we make a comparison between investment and speculation, the
main element that distinguishes both of them is the exposure to risk and
expected return on the sum of investment. In the area of investment, as
discussed earlier, the decision was based on a reasonable assessment of risk to
the accessibility and specific analysis which gives a reasonable profit. This
contrasts with the high-risk speculative activity and provide a high return
rate. Here, the possibility of making a large profit or loss is very high.
Examples of the most common speculation are managing the sale and
purchase of foreign currency or FOREX Market. Today, the speculators are not
really interested in the financial assets; they just wanted to make profit as
we can see today in options and futures commodity markets. In addition, speculation aimed at making a
profit in the short term than the concept of a long-term investment.
Table 1: The differences between
Investment and Speculation
Investment
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Speculation
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Exposure of Risk
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Reasonable –
base on analysis
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High Risk/Unexpected
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Return
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Moderate
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High Return
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Period
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Medium and Long-Term
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Short Term
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Instrument
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T-Bill/Bond/Stock
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Derivative Market/ Speculative Bond/ Stock
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1.3 FINANCIAL SYSTEM’S USERS/CLIENTS
We can divide the customers of the
financial system to the three categories, namely: -
i. Household Sector
Household sector is among the consumers and a major contributor in
the financial system. In general, household’s investments are not only focused
on owning the physical assets such as houses, land and cars but they also
investedin financial assets that have potential and attractive according to
their financial capability. At the same time, households also makefinancial
planningfor their retirement by allocating part of their income that set up by
government or corporate toinvest in the units trust in the market.
Notwithstanding, some of them are also more interested in stocks,
bonds and financial instruments that have higher return with higher risk unit
trusts. Thus, this situation depends on
the consideration of household willingness to accept risk on their investments.
Hence, there are so many financial instruments either conventional or Islamic with
various features today as to attract households to make fair judgments on
investment.
ii. Business Sectors
If the household sector is more focused on the question of where
and how to invest their money, businesses are more focused on how and where
they can obtain financial resources to fund their business. Capital funding is
needed to build factories, buy machinery and equipment, paying wages and
salaries of workers and allow their business operations running smoothly.
In the company's efforts to get their capital, they have a number
of approaches which - to borrow capital from a finance company / bank or issue
a mortgage. Another method is to issue
shares by taking new partners.
The objective for issuance of shares by the company is to get the
best price for the securities issued and also has a lower cost of capital as
compared to bank loan or financialinstitutions.
iii. Government Sector
As business institutions, governments usually require funding to
manage public expenditure. Most of the government revenue is comprises of tax
collection, and if the generating revenue is not enough to cover the
expenditure, the government should consider other methods to meet their needs.
It should be remembered that, the government cannot issue shares as
common practice as companies. They are also not recommended to print a large
amount of money (even though they are basically able to do so) because this
action could lead to inflation and the government usually refrain from doing
so. Thus, the best that could be adopted by the government for long-term
funding is through the issuance of government bonds. As for short-term
financing, the government may offer treasury bills to any interested party.
Table 1 shows the components of assetsand
liabilitiesof USA Government by Board Governors of The Federal Reserve System, Jun
2000.
ASSETS
$
Billion
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% Total
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LIABILITIES
$ Billion
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% Total
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Deposit, currency
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Currency
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25
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0.6
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&gold
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98
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18.05786
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Government securities
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3653.6
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81.8
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Mortgages
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76.8
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14.15146
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(Treasury Bonds)
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Loan
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182.9
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33.70186
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(Treasury Bills)
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Insurance &Reserves Pension
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708.2
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15.9
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Miscellaneous
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76.8
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1.7
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Total
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542.7
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100
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Total
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4463.6
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100
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Refers
to table 1, which consists of Government Securities Treasury bonds and Treasury
bills are among the largest financial contributor to the United States in 2002. A total of 81% state funding is derived from
debt instruments.
Summary:
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• Investment refers to the commitment of
financial resources that we have today hoping to earn a profit / benefit in
the future.
• Investment can occurs either own/invest in
the financial assets or physical assets.
• Investments are made based on consideration
of a reasonable amount of return and risk rather than speculative activities
that addresses the high-risk investment
with the higher expected rate of return. Speculative actions would expose investors
to a higher risk.
• Customers of the financial system are
divided into three main sectors, namely household sector, corporate sector and
government.
• The financial market consists of three main
categories: Money Market, Capital Market and Derivatives Market.
• Money market refers to the short-term
securities or financial instruments, where it has a lower risk and marketable.
• Capital Markets comprise of along-term
financial instruments, where it bears ahigher risk and relatively difficult
to convert into cash and transferred the ownership. The rate of return
offered is higher than the money market instruments.
• Derivatives Markets is a market where a
financial instrument is pegged to the value of an asset or commodity basis.
This market is very useful as a way to protect the value of commodity price
changes dramatically.
• The development of derivatives markets
encourages more traded assets in the
Market, which, include stocks, bonds, commercial papers and etc. The
return on this investment is depends on the movement of performance of the
underlying asset price.
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Discussion:
Part
A: True / False.
1. The government may seek funding
through the issuance of Treasury bills,Treasurybonds, including shares to
finance development expenditure.
2. Investment refers to ownership of
financial and physical assets.
3. The true speculator is not interested
in financial assets that are purchased but they have a profit making motive in their mind.
4. Commercial paper is a medium-term debt
notes which serve as collateral on a loan as to avoid a direct loan from the bank.
5. Business and government sectors are
the main customers of the financial system.
6. Investors are encouraged to invest in
cyclical industries during the economic downturn.
7. The option entitles the holder to buy
or sell assets at determined prices during or before maturity.
8. The contribution on financial assets
isnot much helped as compared to physical
assets in developing a country's economy.
Part B: Essay
- Describe the
relationship that exists between the physical assets and financial assets.
In your opinion which of the assets to give better returns?
- In your
opinion, why individuals should make the investment, whether in physical
assets or financial assets?
- Define the
investment. Why does every individual and organization should give serious
consideration in decision making on investment? Discuss.
- Speculation
is one of the branches of the investment. Explain why investors are not
encouraged to engage in speculative activities. Differentiate between
Money and Capital Markets.
- State four
(4) of Money Market instruments and two (2) ofCapital Market instruments.
- Derivatives
Market is among the fastest growing market in Malaysia, and elaborates on
the market along with the instruments in it.
- Give three
(3) Derivative Market advantages to investors who are involved in processing
of the crude oil industry.
- A company
that wants to raise and require additional capital funds can have several
alternative ways to increase their capital. Please describe the methods or
financial instruments that can be adopted for the long-term financing. A
financial instrument is most suitable for a long term financing? Give your
reasons.
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