Download - Chapter 1 introduction to investment
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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
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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
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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
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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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