Long- Financial Options - Term Paper Example

Subtopic Investment Principles The art of successful investment rests on the foundation of certain basic principles, which generally hold good for all times and places. Moreover, these principles are also readily applicable to all types of investment media, whether it is real estate, shares, government security, bonds, gold, silver, jewellery or collectibles like paintings, stamps and antiques. One may invest in: Physical assets like real estate, gold/jewellery, commodities etc. and/or Financial assets such as fixed deposits with banks, small saving instruments with post offices, insurance/provident/pension fund etc. or securities market related instruments like shares, bonds, debentures etc. The first principle is safety. A safe investment is one, which offers reasonable protection against the risk of capital loss. Success in minimizing investment risks really depends on you, your temperament, and the approach you decide to adopt towards investment matters. Two other ways to minimize investment risks and ensure greater safety are diversification and liquidity. The principle of diversification is best stated in the oft-quoted maxim: never put all your eggs in one basket. Spread your money over a number of widely different assets; buy real state, shares, debentures, government securities, silver paintings or whatever else you consider to be an attractive investment. Diversify geographical in-law not concentrate all your investments in one city, state or region of the country. On the stock market, diversification can be achieved by buying shares in a number of companies, manufacturing different products, operating in different lines of business, belonging to different business houses and catering to different markets. Diversification has the additional advantage of protecting you against your own prejudices and errors of judgemen1It also enables you to hedge your bets, reduce your potential losses, and provides you with an in-built insurance against unforeseen dangers and pitfalls. However, despite many points in its favor, diversification does not provide a satisfactory answer to many investment problems. In the final analysis, diversification is nothing more than average investing. It helps you to get average, or close to average, returns-nothing more, nothing less. Diversification is of little use to you, if you aim to beat market averages and get high returns. For that you will have to deploy your investments in potentially high-return assets and investment media. Moreover, excessive diversification greatly enhances the problem of investment management and control. The more diversified your investments, the greater will be the problems you face in exercising effective managerial control over them. Therefore, as in risk versus return, the successful investor has to balance the advantages and disadvantages of diversification as against concentration. A liquid investment is one, which can be easily sold. An investment that cannot be readily sold and converted into cash is for all practical purposes a dead investment. Liquid investment is one of the basic principles of sound investment. Liquid investments offer many advantages. It can be readily encash during emergencies for meeting unforeseen expenditure. However, liquidity is not an unmixed blessing. The most liquid investments often get relatively poor returns, whereas potentially high return investments like paintings, antiques and other collectibles, agricultural land, rural and small town real estate, low priced bargain shares and turnarounds often have poor liquidity. Stock market investments in shares, debentures and bonds are basically paper investments. They are intangible financial assets, as opposed to physical and tangible assets like land, houses, gold etc. Bank deposits, insurance policies, National Savings Certificates, etc., are also intangible paper investments. Physical assets are generally not only safer investments than paper assets; they also offer greater protection from the ravages of inflation. Therefore, a wise and far-sighted investor tries to spread his money over both physical and paper assets. We would also advise the same course of action. Though we feel that the stock market offers some of the best and most rewarding investment opportunities over the coming decade, we would not advise you to go overboard and put all your eggs in the stock market basket. This could be disastrous. The future contains many imponderables and unforeseen factors, which no human being can possibly identify and take into account. Therefore, it is advisable to safeguard your investments through diversification among physical and paper assets. Though there is no such thing as an ideal or perfect investment, shares come as close to being one as is nowadays possible. They offer high returns in terms of capital appreciation and dividends, or in varying combinations of both. They are liquid investments. In fact, active shares of larger companies are amongst the most liquid of investments available today. They are relatively secure and safe investments, provided that the share portfolio is adequately diversified. Moreover, investments in blue-chip companies and giant, diversified conglomerates are as safe and secure as it is possible for any investment to be. Share investments are also relatively easy to manage and control. They offer equal opportunities to both big and small investors, as investments can be made in shares with very small amounts. This is one of the main reasons behind the current stock market boom and the tremendous interest that the public has begun to take in share investments in recent years. Most people, particularly those with a surplus to invest, now find themselves in a situation where they cannot possibly afford to ignore share investments altogether. Stock markets are not gambling dens but mass-based, government-regulated public institutions, which not only provide a rewarding investment outlet to the ordinary citizen but also enable him to participate in the growth of trade, commerce and industry. (Navjot 61) It is this realization that has contributed to the boom in the share markets. Subtopic 2: Practices And Products With Emphasis On Problems Of The Small Investor Investment means the use of your intelligence, knowledge and skill to make your money earn more money so that your invested capital snowballs over time into a sizeable fortune. It requires time, patience and systematic work. Over a period of time, most investors become reasonably healthy, while some of them even succeed in becoming enormously rich. Quite often, in fact usually, they end up making more money than most speculators and gamblers. Skilful investment decisions alone cannot make you an instant millionaire or enormously rich overnight. For that you need to be a speculator or a gambler with an inborn flair and instinctive feel for the market, combined with a willingness to take great risks. You must also have -a run of consistent good luck. Sudden wealth and big windfall gains depend more on luck, less on skill and knowledge. J. Paul Getty1 was -one such outstanding example. He became the world's richest man and accumulated a vast fortune of over U.S. $ 2 billion but it took him over fifty years of consistent and steady investing to do so. It would be useful for you to ponder over what he says: "Get-rich-quick schemes just don't work. If they did, then everyone on the face of the Earth would be a millionaire. This holds true for stock market dealings as it does for any other form of business activity. Don't misunderstand me. It is possible to make money and a great deal of money-in. the stock market. But it can't be done overnight or by haphazard buying and selling. The big profits go to the intelligent, careful and patient investor, not to the reckless and overeager speculator." (Navjot 57) In the investment market, the heart of the investment process consists of selection, timing, and price. It is all a question of selecting the right company, buying shares in it at the right time and price, and subsequently selling them at the right time and price. Success on the market will therefore hinge on your ability to take the right decisions with respect to selection, timing and price. However, these decisions alone will not enable you to make the amount of money you want. That will depend on the following four factors: The amount of money you initially invest; The period over which the money is invested; The rate at which the invested capital appreciates in value; and The income you receive from your invested capital during this period. Therefore, to achieve investment success you should keep these four factors in mind while taking decisions on selection, timing and price. But this is not all. Successful investing goes for beyond selection, timing and price. It involves the setting of personal investment objectives, formulating an investment plan and adopting a suitable investment strategy. The overall objective of every investor is to make money. To go further, it is to make of every investor is to make money. To go further, it is to make money at a rate that beats the rate of inflating. In other words, the board objective of all investment is to increase, or at least preserve, the purchasing power of invested capital. For a successful investor it is necessary to have a well-defined plan, backed by a carefully conceived investment strategy. This will help you to keep your impulses under control and reduce the subjective element in your investment decisions. A good investment plan is by itself not enough to guarantee investment success. Sometimes, even the best investment plans have flaws, and go awry when implemented in practice. But the fact that you have a plan will stack the odds in your favor and give you a fair chance to win. A well-conceived plan will improve your average results and raise your general level of performance. INVESTMENT BASICS Investment Investment is that form of spending that results in an increase in one's assets. It is a part of the money set aside from your income in order to accrue profits or a further source of income. Savings Savings is usually meant as a fund of money put aside as a reserve. Savings is a part of the money set aside from your income after meeting your expenses. The money saved is usually meant for investment or to meet an expense in the future. Savings is putting money away to reach a short-term goal such as going on holiday or buying a new car. Investing is putting money away for a longer term, in order to earn interest or increase its initial value. (NCFM) Factors That Determine Interest Rates When we talk of interest rates, there are different types of interest rates - rates that banks offer to their depositors, rates that they lend to their borrowers, the rate at which the Government borrows in the Bond/Government Securities market, rates offered to investors in small savings schemes, rates at which companies issue fixed deposits etc. The factors, which govern these interest rates are mostly economy related and are commonly, referred to as macroeconomic factors. Some of these factors are: Demand for money Level of Government borrowings Supply of money Inflation rate Subtopic 3: Tests Of A Good Investment Two Factors That Influence The Price Of A Stock (1) Stock specific: The stock-specific factor is related to people's expectations about the company, its future earnings capacity, financial health and management, level of technology and marketing skills. (2) Market specific. The market specific factor is influenced by the investor's sentiment towards the stock market as a whole. This factor depends on the environment rather than the performance of any particular company. Events favorable to an economy, political or regulatory environment like high economic growth, friendly budget, stable government etc. can fuel euphoria in the investors, resulting in a boom in the market. On the other hand, unfavorable events like war, economic crisis, communal riots, minority government etc. depress the market irrespective of certain companies performing well. However, the effect of market-specific factor is generally short-term. (NCFM) The growth of the mutual fund industry will have the following impact on the stock market: 1. Mutual funds are generally averse to volatile markets characterized by unpredictable and violent share price fluctuations. These markets may delight speculators but they tend to frighten away genuine investors. In the stock market, therefore, mutual funds act as stabilizing forces, using their massive financial clout to prevent market excesses and to somewhat flatten the boom and-slump cycles. 2. Being professionals, mutual fund managers tend to adopt a conservative and text bookish approach to investments. Their investment decisions tend to be strongly guided and influenced by P/E ratios, dividends, order book positions, etc. This too has a sobering influence on the markets. Their buying and selling decisions tend to bridge the gaps in the P/E ratios, book values, etc. 3. Since mutual fund managers handle large sums of money they tend to zero in on companies with large equity bases. The share prices of companies with large equity bases tend to get an upward boost in stock markets dominated by mutual funds. 4. The general level of P/E ratios tends to be higher in stock markets dominated by mutual funds. This is because mutual fund managers tend to have a longer time horizon and are, therefore, more inclined to go in for longer-term investments. Fund managers also tend to be averse to short-term losses. 5. Mutual fund managers not only tend to be slow to react to market developments but also are also reluctant to change their investment techniques and investment philosophy. This puts them in a tremendous disadvantage in a market where the "rules of the game" are constantly changing. Subtopic 4: Analysis Of Risk Risks involved in investing in Mutual Funds Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures, bonds etc. All these investments involve an element of risk. . Some of the Risk to which Mutual Funds are exposed to is given below Market risk If the overall stock or bond markets fall on account of overall economic factors, the value of stock or bond holdings in the fund's portfolio can drop, thereby impacting the fund performance. Non-market risk Bad news about an individual company can pull down its stock price, which can negatively affect fund holdings. This risk can be reduced by having a diversified portfolio that consists of a wide variety of stocks drawn from different industries. Interest rate risk Bond prices and interest rates move in opposite directions. When interest rates rise, bond prices fall and this decline in underlying securities affects the fund negatively. Care To Be Taken While Investing Before making any investment, one must ensure to: 1) Obtain written documents explaining the investment 2) Read and understand such documents 3) Verify the legitimacy of the investment 4) Find out the costs and benefits associated with the investment 5) Assess the risk-return profile of the investment 6) Know the liquidity and safety aspects of the investment 7) Ascertain if it is appropriate for your specific goals 8) Compare these details with other investment opportunities available 9) Examine if it fits in with other investments you are considering or you have already made 10) Deal only through an authorized intermediary 11) Seek all clarifications about the intermediary and the investment 12) Explore the options available to you if some thing were to go wrong, and then, if satisfied, make the investment. These are called the Twelve Important Steps to Investing. Subtopic 5: Sources Of Information It can be truly said that information is the name of the game that is played in the stock markets. Whether you are a speculator or an investor, your success in the stock market hinges upon the amount and quality of information to which you have ready and timely access, and your ability to sift, understand, evaluate, and finally interpret it correctly to reach the right conclusions. Even the most seasoned of stock market operators will not be able to understand a given situation, reach the right conclusions and make the right decision on time, unless they are constantly supplied with adequate and relevant information. This is why you will often observe that seasoned and successful investors and speculators often convey the impression of being veritable storehouses of information and knowledge. People who met J.Paul Getty were often astounded by the vast range of information and knowledge that he carried in his head.2 His frequent advice to investors was that, 'No one should ever buy a stock without knowing as much as possible about the company that issues it'. (Navjot 75) Without the support of adequate and timely information, all investment is reduced to a 'Hit-or-miss affair' or a blind groping in the dark' Information-based decisions often convert high-risk, uncertain, speculative ventures into safe investments with relatively assured returns. In fact, in some situations information is the only factor that distinguishes speculation from investment. People have made and lost fortunes simply because they didn't get the right information in time or because they failed to interpret it correctly to reach the right conclusions. Reliance Industries is now widely recognized and accepted as having provided one of the best investment opportunities in the last eight years. Yet thousands of investors either failed to climb onto the Reliance bandwagon or climbed off prematurely because they could not correctly interpret the much-publicized information about its breath-taking growth rate, dynamic management, excellent labor relations, penchant for continuous up gradation of technology and massive plans for future growth and expansion. They misinterpreted this information to reach the conclusion that Reliance is a bubble that is soon likely to burst. This erroneous impression continues to linger even up to this day. In the stock markets, basically four categories of information are really required: (i) Information on the economy and broad socio-economic trends. (ii) Information on the required industry and the critical factors that affect the performance, and future prospects of the industry. (iii) Information on the company and its operating environment. (iv) Information on the technical position of the stock market, i.e, the buying and selling pressures that are going to determine share prices and give shape and direction to future price movements. In fact, in the stock market there is no such thing as relevant and irrelevant information. All information is relevant. It is not possible for any investor to cope with or handle such broad based information indiscriminately. For most investors, information belonging to the four categories specified above is sufficient for achieving investment success. Now how does one obtain this information Normally investors receive information from five clearly identifiable sources. Let us take them up one by one. Publications The investment business is now well serviced by a wealth of information from numerous publications ranging from daily newspaper and financial dailies to the stock exchange, yearbooks, market letters and stockbrokers publication for their clients. Above all, these advisory -reports and newsletters can serve as early warning signals in making you aware of your mistakes and errors of judgment. Over a period of time you will discover that no serious investor can really afford to ignore altogether these investment advisory reports and newsletters. Now your problem will be to decide which ones to subscribe to, and which ones to ignore. It is difficult to solve this problem for you because each person's reaction to an investment newsletter or report is peculiarly subjective. However, some guidelines for selecting a suitable investment advisory service or investment newsletter. 1 To begin with you should subscribe to as many of these investment advisory newsletters as you can afford and find time to read and assimilate. As a general rule, you should spend at least one per cent of your total portfolio every year in getting investment information and advice. This is essential not only for making fresh investments but also for the management and protection of your existing investments. You will find that not only is the expense worth it, but subscriptions to such newsletters may well turn out to be the best investment you have ever made. Even one good idea for buying or selling a particular share obtained from a particular newsletter will more than pay for a couple of years' subscription to that newsletter. 2 Select only those investment newsletters that back up their recommendations with facts, analysis and reasoning. Try to avoid newsletters that base their recommendations on tips, inside information and market gossip. 3 Newsletters that give their recommendations in the light of broad socio-economic and industrial trends are generally better and will tend to give sounder advice than those, which simply depend upon corporate news and current share price movements. 4 Select a newsletter that caters to your particular brand of investment philosophy. For example, if you are a speculator or short-term trader do not subscribe to a newsletter that caters only to the needs of long-term investors. Or if you are interested in investment that give safe and steady returns, then don't subscribe to a newsletter that promises to multiply your capital quickly through high-risk speculative investments. 5 Finally, choose a newsletter whose views and advice tend to be future-oriented as opposed to those, which are rooted in the present, or those, which tend to give undue importance to the past. You would do well to remember that advice, particularly bad and uninformed advice, is the cheapest commodity in the world. When you start investing you will find yourself flooded with advice from friends, relatives, passers-by in the street and casual acquaintances. They will bombard you with all kinds of advice backed by theories, alleged facts, explanations and wisdom'. As a result, you will find it exceedingly difficult to separate the really good advice from the large volume of trash that you receive every day. But if you have a well-conceived and clearly-defined investment objective and plan, you will find it easier to recognize and separate good advice from bad, and know how to put such advice to the best possible use. No amount of advice, even the best available advice coming from the most seasoned and intelligent investment adviser, can really benefit the ignorant, confused and lazy investor. Subtopic 6: Various Types Of Investments Various Short-Term Financial Options Available For Investment Broadly speaking, savings bank account, money market/liquid funds and fixed deposits with banks may be considered as short-term financial investment options: 1. Savings Bank Account is often the first banking product people use, which offers low interest making them only marginally better than safe deposit lockers. 2. Money Market or Liquid Funds are a specialized form of mutual funds that invest in extremely short-term fixed income instruments and thereby provide easy liquidity. Unlike most mutual funds, money market funds are primarily oriented towards protecting your capital and then, aim to maximize returns. Money market funds usually yield better returns than savings accounts, but lower than bank fixed deposits. 3. Fixed Deposits with Banks are also referred to as term deposits. Fixed Deposits with banks are for investors with low risk appetite. Various Long-Term Financial Options Available For Investment Issues, Public Provident Fund, Company Fixed Deposits, Bonds and Debentures, Mutual Funds etc. Initial Public Offering (IPO) Initial Public Offering is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer's securities. An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer's securities. The sale of securities can be either through book building or through normal public issue. (NCFM) Mutual Fund A mutual fund is an investment company or an organization, which invests the pooled contributions of a large number of small investors (shareholders) for their mutual (common) benefit. Its basic concept is that of collective investment under expert professional guidance for mutual benefit. Bonds Bond is a negotiable certificate evidencing indebtedness. It is normally unsecured. A company, municipality or government agency generally issues a debt security. A bond investor specified lends money to the issuer and in exchange, the issuer promises to repay the loan amount on a maturity date. The issuer usually pays the bondholder periodic interest payments over the life of the loan. The various types of Bonds are as follows: (Dyjan 21) Zero Coupon Bond: Bond issued at a discount and repaid at a face value. No periodic interest is paid. The difference between the issue price and redemption price represents the return to the holder. The buyer of these bonds receives only one payment, at the maturity of the bond. Convertible Bond: A bond giving the investor the option to convert the bond into equity at a fixed conversion price. Securities Securities Markets is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc. Further, it performs an important role of enabling corporate, entrepreneurs to raise resources for their companies and business ventures through public issues. Securities one can invest in are Shares Government Securities Derivative products Units of Mutual Funds etc. are some of the securities investor in the securities market can invest in. Shares: When you buy a share of a company you become a shareholder in that company. Shares are also known as Equities. Equities do have the potential to increase in value over time. It also provides your portfolio with the growth necessary to reach your long-term investment goals. EquityShares: An equity share, commonly referred to as ordinary share, represents the form of fractional ownership in a business venture. Rights Issue/ Rights Shares: The issue of new securities to existing shareholders at a ratio to those already held, at a price. Bonus Shares: Shares issued by the companies to their shareholders free of cost based on the number of shares the shareholder owns. Preference shares: Owners of these kind of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank below the claims of the company's creditors, bondholders/debenture holders. Cumulative Preference Shares: A type of preference shares on which dividend accumulates if remained unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares. Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company. Equities are considered the most challenging and the rewarding, when compared to other Investment options. CONCLUSION Finally, a successful investor has got to be future oriented .He has to stop peering over his shoulder into the past and start scanning the horizons of he future .The past is buried .It is the future where all the action is going to be. Therefore the investor should take an intelligent look into the future and make an assessment of what is gong to be like. The investment decisions will have to be based on this assessment. The difference between success and failure will depend upon individual's ability to forecast the future accurately. In a nutshell, successful stock market investing is the art of spotting tomorrow's winners today Work Cited American History. Information on Jean Paul Getty. [http://www.answers.com/topic/j-paul-getty] Dodi M. "Business Economics", PAICO Publications, Delhi, India. Dyjan A. "All About Money" H & C Publications .New Delhi, India. Grewal SS & Grewal N. Successful Stock market Investing. Vision Books. p 14-135 Kelkar R V. "Understanding Indian Stock Exchange." Pen book Publications. Mumbai Thompson V. "Money Talks." Express Publications New Delhi, India. 2006. NYSE Group, Inc. (n.d.); Listed Company Directory; Retrieved January 20, 2007, Retrieved [http://www.nyse.com/listed/listed.html] Navjot G. Profitable Investments in Shares: A Beginner's Guide. Careers.2002. p 57-144 Richard Loth. Investopedia, Inc (2007); Analyze Cash Flow the Easy Way; Retrieved January 20, 2007, [http://www.investopedia.com/articles/stocks/07/easycashflow.asp] Read More