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INTRODUCTION TO I n v e s t m e n t

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Terminology

Finance – commercial or government activity of

managing money, debt, credit and investment

Investment – the current commitment of resources in order to achieve later benefits present commitment of money for the purpose of receiving

more money later – invest amount of money then your capital will increase

Investor is a person or an organisation that buys shares or pays money into a bank in order to receive a profit

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INVESTMENT SPECULATION GAMBLING

Objective Specific goal/objectives

Objectives, only to gain high return

Based on LUCK

Risk Low risk Moderate to high risk

High risk

Period Long term Short term Short term

Analysis Fundamental analysis

Technical analysis or based on herding behavior

No analysis

Return Current income (dividend, interest)

Capital Gain Capital Gain

Real assets are tangible things owned by persons and businesses Residential structures and property Major appliances and automobiles Office towers, factories, mines Machinery and equipment

Financial assets are what one individual has lent to another Consumer credit Loans Mortgages

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The household is the primary provider of funds to businesses and government.

Households must accumulate financial resources throughout their working life times to have enough savings (pension) to live on in their retirement years

Financial intermediaries transform the nature of the securities they issue and invest in

Banks, trust companies, credit unions, insurance firms, mutual funds

Market intermediaries simply help make markets work

Investment dealers Brokers

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FIGURE 1-2

Household

GovernmentBusiness

Household

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FIGURE 1-3

Banks and other deposit-taking institutions

Insurance companies Pension Funds Mutual Funds

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Insurers sell policies and collect premiums from customers based on the pricing of those policies given the probability of a claim and the size the policy and administrative fees.

They invest the premiums so that the accumulated value in the future will grow to meet the anticipated claims of the policyholders.

In this way, unsupportable risks (such as the death of wage earner or the burning down of a business) are shared among a large number of policyholders through the insurance company.

Insurance allows households, business and government to engage in risky activities without having to bear the entire risk of loss themselves.

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Individuals and employers make payments over the entire working life of a person with those funds invested to grow over time.

Ultimately, the accumulated value in the pension can be used by the person in retirement.

Pension plans accumulate considerable sums of money, and their managers invest those funds with long-term investment time horizons in diversified portfolios of investments. These investments are a major source of capital, fuelling investment in research and development, capital equipment, resource exploration and ultimately contributing in a substantial way to growth in the economy.

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Mutual funds give small investors access to diversified, professionally-managed portfolios of securities.

Small investors often do not have the funds necessary to invest directly into market-traded stocks and bonds.

This is called denomination intermediation because the mutual fund makes investments available in smaller, more affordable amounts of money.

Canadian indirect investment in the markets through managed products such as mutual funds and segregated funds has grown exponentially.

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There are two major categories of financial securities:

1. Debt Instruments

– Commercial paper– Bankers’ acceptances– Treasury bills– Mortgage loans– Bonds– Debentures

2. Equity Instruments

– Common stock– Preferred stock

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Characteristics of non-marketable securities Cannot be traded between or among investors May be redeemable (a reverse transaction

between the borrower and the lender) Examples:

Savings accounts Term Deposits Guaranteed Investment Certificates Canada Savings Bonds

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Investment/Financial Instruments

Characteristics of Marketable securities Can be traded between or among investors after their

original issue in public markets and before they mature or expire.  

Equit or debt instrument (share/stock, bond, note) that is listed on an exchange and can be readily bought or sold. A marketable security is a near-cash (liquid) asset and is recorded at acquisition cost (purchase price plus incidentals, commissions, and taxes) or market value (whichever is lower) in the account books under current assets. Non-marketable securities include savings bonds and restricted shares/stock.

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Markets can be categorized by the time to maturity: Money Market Securities (for short-term debt

securities that are pure discount notes) Bankers’ acceptances Commercial Paper Treasury Bills

Capital Market Securities (for long-term debt or equity securities with maturities greater than 1 year) Bonds Debentures Common Stock Preferred Stock

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Primary Market Markets that involve the issue of new securities by the

borrower in return for cash from investors (Capital formation occurs)

Secondary Market Markets that involve buyers and sellers of existing

securities. Funds flow from buyer to seller. Seller becomes the new owner of the security. (No capital formation occurs)

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Exchanges or Auction Markets Secondary markets that involve a bidding

process that takes place in specific location For example TSX, NYSE, Malaysian Stock

Exchange Dealer or Over-the-counter (OTC) Markets

Secondary markets that do not have a physical location and consist of a network of dealers who trade directly with one another.

For example the bond market

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Third Market Trading of securities that are listed on organized

exchanges in the Over-the-counter market

Fourth Market Trading of securities directly between investors

(usually between two large institutions) without the involvement of brokers or dealers.

Operates through the use of privately owned automated systems such as Instinet

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Represents an important source of funds for borrowers

Provides investors with important alternatives as they seek to build wealth through diversified portfolios

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In this chapter you have learned about: Financial systems in general. Major participants in the financial system,

including the different types of financial securities and financial markets

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