MEANING OF INVESTMENT AND ITS TYPES

 

Think of some activities such as buying stock of Nepal Bank Ltd, bond issued by the government, or a

piece of land in your town. These activities, which are examples of investment, have some common characteristics: you need money to get the assets now, you do so in an expectation of returns in future, and you bear risk when you buy these assets. Based on common characteristic of investments, we may define investment  as commitment of current resources in the expectation of deriving greater resources  in the future. In other words, it is the sacrifice of certain present value for ( possibly uncertain) future value.

Investments is made broadly into two types of assets: Real assets and Financial Assets. Real assets possess productivity capacity, hence are used to produce goods and services. Examples of real assets are property, land, building, human capital, plants, equipment, etc., Financial assets represent claim on income and other assets and define the allocation of wealth or income. Examples of financial assets are shares, bonds, treasury securities, etc.

Types of Investment

The investment may be classified into various ways depending upon the nature and investment or the process we adopt in the investment.

Securities or properties

Broadly our investments are either in securities (financial assets) or properties (real assets). Securities represent legal right on income or assets. Common stocks, bonds, and derivatives are examples of securities. If you own common stock of a company, you have ownership right on the properties of that company. If you own bond of a company, you have right to receive interest on your investment on bond  of that company.

If you own derivatives, you have special rights to buy or sell an asset depending upon the nature of derivative security. Properties are tangible in nature and possess productive capacity or preserve value. Land, building, gold, artworks, etc are the examples of properties. Properties may be further classified as real properties and tangible personal properties. Real properties, such as land and building, are permanently affixed to the land. Tangible personal properties include items such as gold, antiques, artworks, and other collectibles.

Direct or Indirect Investment

Investment may be classified as direct or indirect depending on the way we acquire a claim on the asset and exercise our right on ownership or an income. Investment in common stock or bond is an example of direct investment. For example, if you invest in the stocks of Nabil Bank, you have direct claim on asset and dividends of Nabil Bank. But in the case of indirect investment, your claim is indirect. Investment in mutual fund is indirect investment, it is because mutual funds invest primarily in securities of other companies. Your money invested in mutual funds is indirectly used by the third party.

Debt, equity or derivative securities

 the type of investment in which an investor invests could be a debt security, an equity security, or a derivative security. The rights and privileges of the investors differ depending upon the type of securities invested in. As an investor in a debt security like bond, the investor is lending money to the company. The investor has right to receive interest as promised and get the money back at the maturity of the bond. If an investor invests in equity security, the investor becomes an owner of the company. As an owner he/she possesses residual right on assets and income but doesn’t have right to claim on dividend. By investing in the derivative security, the investor has right to buy or sell the underlying asset on which the derivative is written. Options and warrants are examples of derivative securities. Call option gives you right to buy stock at predetermined price and put option gives you right to sell stock at predetermined price.

Low or High Risk Investment

Risk in finance is defined as the chance that the actual return will differ from the expected return. Securities with higher deviation between the expected and actual returns are considered riskier. Securities differ in terms of risk they possess. In general, derivative securities are considered riskier than common stock, which in turn are considered riskier than bond. There are some investment alternatives which are risk-free while there are some which are considered speculative. Risk-free securities offer certain returns. For example, investment in insured bank account and investment in short-term government securities such as treasury bills are risk-free. There are other securities such as derivatives and junk bonds which are very risky and investment in these securities are considered high risk investment. In between risk-free and high risk investments, there is low risk investment.

Short-term or long-term Investments

Investments are classified as short-term or long-term investments depending upon the maturity period

securities. Investment in securities having maturity less than one classified as short-term investment and investment in securities having maturity more than one year is classified as long-term investment. Investments Treasury bills, commercial papers, bankers’ acceptances are examples of short term investments; and investments in bonds and common stocks are examples long-term investment.

Domestic or Foreign Investments

Investments made in the securities issued by companies of home country investments in securities issued by are known as domestic investment and security issued by foreign-based companies are known foreign investment. Investments in foreign securities such as bonds, common stocks and derivative securities are common practice in developed markets, bi there are restrictions in foreign investment in many developing countries.

Types of Investors

Investors are classified as - individual investors and institutional investors

Individual Investors manage their own funds to achieve personal investment goal. Their personal goal may be to earn return on their surplus fund, secure retirement income, and provide security for their family members. But for many individual investors it is difficult to realize their virtuous goal because of some inherent limitations among themselves. For example, many individual investors have very small amount to invest and lacks knowledge and and professional Skills for taking Investment decision.

Institutional Investors manage other people’s money. Mutual funds, pension funds, provident funds, life insurance companies, banks are the examples of institutional investors. They pool money from individual investors and create a large sum of money to invest, use professional skills to evaluate investment alternatives and invest in wide ranges of securities. Though both individual and institutional investors apply same fundamental principles of investing, the classification is useful because these two types of investors often follow different investment process.