INVESTMENT 'VEHICLES'

Meaning of Investment Vehicle

Investment vehicles refer to the investment alternatives in which investors can invest their funds. They differ in terms of cost, risk, return, maturity, and tax considerations. At this stage, it is useful to understand the fundamentals of investment alternatives so that we can make the proper choices. These alternatives may be classified into many ways such as:

• Short-term Vehicles
• Common stock
• Fixed-income securities
• Mutual Funds
• Derivative securities
• Others

Short-term Vehicles

Short-term vehicles are of less than one-year maturity. They are highly liquid and less risky, therefore, they yield a low return. Treasury bills, commercial papers, bankers’ acceptance, negotiable certificates of deposits, etc., are examples of short-term vehicles.

Common Stock

Common stock is an ownership securities. It means the investors of common stock becomes the owner of the company. Each share of common stock represents a fractional ownership interest in the firm. The investors receive dividends periodically out of the profit of the company. The dividend to common stockholders comes after paying interest to the bondholders and preference dividend to preferred stockholders; hence, it is not sure that common stockholders get the dividend of the company. The investors may also gain by selling their shares at a higher price than they originally purchased and such gain is known as a capital gain.  Thus, the returns on investment of common stock consist of dividends and capital gain. Since both are uncertain, the investment in common stock is rather riskier than the investment in fixed-income debt securities.

Fixed-income Securities

fixed-income securities provide fixed returns to the investors irrespective of the profit of the firm. They are popular investment alternatives to investors who prefer regular income. Fixed-income securities are of different kinds- bonds, convertible securities, and preferred securities. A bond is a long-term debt instrument issued by the government or corporations. Investors who invest in bonds are entitled to receive periodic interest and return of the face value at the maturity period of the bond. Government bonds are safer than corporate bonds hence offer a lower return. Convertible securities offer the investors to convert them into a specified number of shares of common stock. Therefore, investors of convertible securities have opportunities to receive fixed interest until the security is converted into common stock, and take advantage of price appreciation of stock by converting convertibles into common stock. Another fixed-income security is preferred stock. Preferred stock represents, unlike bonds, ownership interest in a corporation. The investors have preferential rights to receive the dividend before the common stockholder receives the dividend. But they are paid the dividend after bondholders are paid interest. Therefore, preferred stock is riskier than bonds but less risky than common stocks. Fixed-income securities are traded in organized exchanges and OTC markets.

Mutual Funds

Mutual fund companies sell shares (units) of mutual funds and create a pool of funds. This fund is invested in securities and managed by professionals employed by the companies. The shares of the funds are useful investment alternatives, particularly to small investors. Mutual funds are also of two types: closed-end and open-end funds. Closed-end funds sell shares to raise a fixed amount of money. Most of the mutual funds in Nepal are closed-end schemes. The shares of closed-end funds are listed in stock exchanges and can be traded in the same manner as for the common stocks. Open-end funds issue shares and stand ready to buy back shares from the investors.  In other words, units of open-end funds are bought from and sold to the same company which manages the fund. They are not traded on the organized exchange.

Derivative securities

Derivative securities derive their value from an underlying security or asset. To illustrate the concept of derivative security, let us take an example of the call option which is derivative security. Suppose a dealer of securities issue a call option and you bought it. The option gives you the right to buy a specified number of shares (say 100 shares) of a particular stock (say X stock, which is the underlying asset of the option) at a specified price (say Rs.200)  before the specified date (say 20 June). Now, suppose the price of stock increases to Rs.220. in this situation, you buy stocks from securities dealers at Rs.200 each and sell them at the market at Rs.220 each in the market. The security dealer who had sold you the option is obliged to sell you the stock at Rs.200 through the stock in the market is selling at Rs.220. what happens if the market price remains below Rs.200 before the specified date? The price you paid to buy the option is lost. Therefore, derivative securities are risky investment alternatives.

Others

besides the above-mentioned types of investment alternatives, there are so many other alternatives available to the investors. For example, you may invest in real estate, bullion, collectibles, etc.