Investment Decisions - Essay Example

fff Table of Contents PART ONE Introduction PART TWO 4 Bond 4 Investing in venture capital 6 Investing on the stock market 8 Effects of economic forces on financial markets 8 PART THREE 9 Making Decision to invest 9 Present Value of a Lump sum 10 Present Value of an Annuity 11 Present Value of Uneven Periodic Sum 12 Net Present Value Method 13 Conclusion 14 References 15 PART ONE Introduction An exchange-traded fund (ETF) is a type of investment where the investor is spreading their money around a particular sector of the economy or type of investment. In this way, an ETF acts like a mutual fund. There are differences between an ETF and a mutual fund though. Most investors that are more active prefer ETF more than a mutual fund because the ETF is easily traded. A mutual fund does not have real time price quote updates all throughout the day. Rather, with a mutual fund you are going to find that the prices just updates at the end of the day. This means that you have to wait until the end of the day if you are hoping to cash out of a mutual fund. That is different from what you are able to do with the ETF. (Pandey 2006) This part will show how invested in the stock market. Being accountant working as middle level graduate manager, I found it easy to invest in the stock market because of some of the merits has compared with other means of investments. Investing in the stock market involve approaching share broker and have some purchase of shares. This how I did, with technology and years of brokerage price wars have changed all that, to the point where, for less than fifty cash, I could buy a fully diversified portfolio of thousands of stocks and pay pennies in expenses. Therefore, I went looking for an online brokerage that treats the low-dollar investor right. These were my criteria: No minimum opening balance—in fact, no minimum balance and period. Access to diversified, low-cost, commission-free stock and bond ETFs. ( Matthew Amster-Burton). Investing is multidimensional process that starts with the first question a person asks (how to invest) himself and approaches others when he wants to invest in share market. You should have a clear vision when you want to reap the benefits that are the returns. If you want to pull out the invested money in short term, you should choose the critical moving sectors and shares and do not act blindly on the third party suggestions. If you want to have the investment to be taken by your generation, then you can go for Long Term investment. In long-term investment, one should analyze the pure fundamentals of the company, the dividend amount it pays to the shareholders, the capital and the percentage of share ratio between the company and the public. Investing National stock exchange Nairobi stock exchange is market commonly called NSE. It is like any other market but it trades share. It provides platform where investor can buy and sell shares.it have the following merits for it makes idle funds productive by making lender and investor meet at very low cost.it also provide a good management of the companies for it allows companies to come up with reports on managements thus facilitates good managements. To start with, I bought share that were initial public offer (IPO).This is situation a company trade its shares for the first time in the market. With my little income, I received income as dividends. Through this, I got some income through capital gain. Capital gain is calculated as Capital gain is assumed to constitute the difference between the buying price of a share at the beginning of the (P0), the selling price of the same share at the end of the period (P1). Therefore total returns = DPS + Capital gains = DPS + P1 – P0. The amount invested to derive the returns is equal to the buying price at the beginning of the period (P0) therefore percentage return/yield = Total returns x 100 = DPS + P1 – P0 x 100 Investment P0 Thus at the end of the day I benefited because obtained dividends and stock share appreciated in value from $ 5 that was trades during IPO to $5.80, thus a gain of 80 cents per share. It is evident with good research and bit of knowledge in the stock market one can make a good fortune without sweating or doing much paper work of managements. Many investors let their portfolio to lie idle in their banks accounts instead they can make some returns for investing in the stock market. PART TWO This part going to analysis that show which is the best way to invest in share market. We shall compare some investments instruments like bonds, shares and venture capital Bond A bond is a loan between the lender and borrower, the borrower promise to pay the lender some agreed amount at future. Can be annually, semiannually, quarterly or monthly depending on their agreement. In case of emergence, the investor can sell the bond in in markets easily. The interest of the bond grows daily and each day the bond has different value in the market. This implies that there is no penalty of selling bond before maturity. The bond has advantage over other instruments for an investor can buy a bond that its interest matches with school fees, car medical fee. It is easy to transferable. Besides the above-discussed merits they are also That is, bonds represent debt, and stocks represent equity ownership. This difference brings us to the first main advantage of bonds: in general, investing in debt is safer than investing in equity. The reason for this is the priority that debt holders have over shareholders. If a company goes bankrupt, debt holders are ahead of shareholders in the line to be paid. In a worst-case scenario such as bankruptcy, the creditors (debt holders) usually get at least some of their money back, while shareholders often lose their entire investment. Sometimes bonds are just the only decent option. The interest rates on bonds are typically greater than the rates paid by banks on savings accounts. As a result, if you are saving and you do not need the money in the short term, bonds will give you the greatest return without posing too much risk. Moreover, most cases the bank have restriction on withdrawal on ones funds thus incase of emergence one cannot be helped. The bottom line is that bonds are a safe and conservative investment. They provide a predictable stream of income when stocks perform poorly, and they are great vehicles for saving when you do not want to put your money at risk. However investing in bond has some setbacks, A few of those include no hedge against inflation as interest rates rise which causes bond prices to fall, prices can be quite volatile due to market interest rates varying after a bond is issued, bonds have lower returns than stock. In the long term, individual bonds do not compound their interest; taxes will be owed on capital gains and losses when selling before maturity and interest unless the bonds are tax-exempt. Because bonds tend to be safer than stocks, the down side is that they also will pay less than stocks. Investing in stocks or bonds is a battle between stocks dividends. Historically, bonds that are long term tend to be more volatile than short-term bonds. While the investor may be looking for a long-term income stream, long-term bonds are more risky because the bond principle itself is only as safe as the company holding it. Meaning if the company becomes unstable, the possibility of default on the bond payment increases. Investing in venture capital Venture capital is a form of investment in new small risky enterprises required to get them started by specialists called venture capitalists. Venture capitalists are therefore investment specialists who raise pools of capital to fund new ventures, which are likely to become public corporations in return for an ownership interest. They buy part of the stock of the company at a low price in anticipation that when the company goes public, they would sell the shares at a higher price and therefore make a considerably high profit. Venture capitalists also provide managerial skills to the firm. Examples of venture capitalists are pension funds, wealthy individuals and insurance companies. This also best option of investments and with good managements one can get a good some of money. Since the goal of venture capitalists is to make quick profits, they will invest only in firms with a potential for rapid growth. Venture capitalists, will only invest in a company if there is a reasonable chance that the company will be successful. Their publicity material states that successful investments have three common characteristics. There is a good basic idea, a product or service, which meets real customer needs. There is finance; in the right form to turn, the idea into a solid business. There is the commitment and drive of an individual or group and the determination to succeed.(Pandey 2009) Venture investment is best option because of the following attributes, equity participation Venture Capital participate through direct purchase of shares or fixed return securities (debentures and preference shares) Long-term investment – venture capital is an investment attitude that necessitates the venture capitalists to wait for a long time (5 – 10 years) to make large profits (capital gains). Participation in Management – Venture capitalists give their Marketing, Planning and Management Skills to the new firm. This hands – on Management enable, them protect their investment. In sum, venture capital, by combining risk financing with management and marketing assistance, could become an effective instrument in fostering the investment. The experiences of developed countries and the detailed case study of venture capital. However, indicate that the following elements are needed for the success of venture capital in any country. A broad-based (and less family based) entrepreneurial traditional societies and government encouragement for innovations, creativity and enterprise. A less regulated and controlled business and economic environment where an attractive customer opportunity exists or could be created from high-tech and quality products. Existence of disinvestments mechanisms, particularly over-the counter stock exchange catering for the needs of venture capitalists. Fiscal incentives that render the equity investment more attractive and develops ‘equity cult’ in investors. A more general, business and entrepreneurship oriented education system where scientists and engineers have knowledge of accounting, finance and economics and accountants understand engineering or physical sciences. An effective management education and training programme for developing professionally competent and committed venture capital managers; they should be trained to evaluate and manage high technology, high risk ventures. A vigorous marketing thrust, promotional efforts and development strategy, employing new concepts such as venture fair clubs, venture networks, business incubators etc. for the growth of venture capital. Linkage between universities/technology institutions, R & D. Organisations, industry, and financial institutions including venture capital firms. Encouragement and funding or R & D by private public sector companies and the government for ensuring technological competitiveness. Investing on the stock market When it comes to figuring out how the economy is doing, people typically look to how the stock market is doing to get a shallow impression of how investors perceive the economic future. For sure, if utilized correctly, the stock market is a huge ocean of opportunity. You can use it to make millions, build a passive income, speculate for fun, or slowly invest for retirement. You can use the stock market to store investments or to increase profits. Most of the people don’t understands how stock market operates. However, stock market operations are not big secret and once an individual understands how the market works, the unease disappears. Think of the stock market as an auction filled with intermediary parties who match sellers and buyers of stock. Once a company goes public, its shares of stock are purchased and sold on stock markets. Investing on the share market has advantages and most preferred. Despite its appearance of chaos, the stock market actually uses a very organized and methodical system for trading. A stock price is determined by the rules of supply and demand within an auction environment. Though the specialists match the sellers with the buyers, the shares of stock are always sold to the individual with the highest bid. Effects of economic forces on financial markets Cost of finance is related with rate of interest rate. Since business is very risky the cost of finance is higher than interest rate thus cost of finance changes with changes of interest rate. Thus, overall cost of fund is given as rate of interest + risk premium. Rate of interest reflects expectation of inflation. There exist the relationship between the cost of fund and rate of interest that is 1+cost of finance=(1+interest rate)(1+risk premium). Economic forces also come to play for example if the state employs macroeconomic policies such fiscal and monetary policies. Money in circulation will increase or decrease significantly thus affect economics and finance decisions. For example expansionary monetary policy will increase money in circulation while contractionary will decrease. This result bank responding on the same thus adjust their interest rate accordingly. Business cycle also affects investments decisions. For example if economy is at recession investors, take less economic actions. During the boom, more investments are expected because of higher returns. At the recovery period, same thing is expected as boom period. PART THREE Making Decision to invest To come up with informed decision one need to study ways to measure which investment tool is appropriate to invest in that can yield higher income. Various models have been developed to measure such ways they include, Present Value Concept, Present Value of a Lump sum, Present Value of an Annuity, Present Value of Uneven Periodic Sum and Net Present Value Method. We shall make use of some of these models to calculate which option yield higher income (returns).our investment amount is 50000 euros Present Value Concept This concept acknowledges the fact that a shilling losses value with time and as such if it is to be compared with a shilling to be received in Nth year then the two must be at the same values. This means that an investor’s analytical power is increased by his/her ability to compare cash inflows and outflows separated from each other by time. He/she should be able to work in the reverse direction i.e. from future cash flows to their present values. Present Value of a Lump sum Usually an investor would wish to know how much he/she would give up now to get a given amount in year 1, 2, … n. In this situation he would have to decide at what rate of discount also known as time preference rate, he/she will use to discount the anticipated lump sum using this rate by applying the following formula: Where: Pv = Present value L = Lump sum K = Cost of finance or time preference rate n = given year. Investing 50000 for say 4 years will yield the following The present value of inflows to be received in the 2nd year to Nth year, will be equal to: Annual cash flows is pv*(1+k)4 =50000*(1.1)4 50000* 1.4641= 73205 Thus returns = 23205 after 4 years Where: A = annual cash flows N = Number of years In addition, the present value of a shilling to be received at a given point in time can in addition to using the above formula is found using the present value tables. Present Value of an Annuity An individual investor may not necessarily get a lump sum after some years but rather get a constant periodic amount i.e. an annuity for certain number of years. The present value of an annuity receivable where the investor time preference is 10% equal to: I = time preference rate E.g. Pv of 1/= to be received after 1 year if time preference rate is 10%. = After 2 years it will be: 1st year - 0.9090 2nd year - 0.8264 3rd year - 0.7513 4th year - 0.6830 Total - 3.1697 Thus A=(50000*3.1697)/4= 39621.25… This annual cash flows Present Value of Uneven Periodic Sum In investment, decisions it is very rare to get even periodic returns and in most cases a company will generate a stream of uneven cash inflows from a venture and the present value of those uneven periodic sums is equal to: Equation Where: At = Uneven cash inflows at time t Pv = Present value K =Cost of finance Net Present Value Method The method discounts inflows and outflows and ascertains the net present value by deducting discounted outflows from discounted inflows to obtain net present cash inflows i.e the present value method will involve selection of rate acceptable to the management or equal to the cost of finance and this will be used to discount inflows and outflows and net present value will be equal to the present value of inflow minus present value of outflow. If net present value is positive you invest, If NPV is negative you do not invest. Pv(inflow) – Pv(outflows) = NPV Initial outflow is at period zero and their value is their actual present value. With this method, an investor can ascertain the viability of an investment by discounting outflows. In this case, a venture will be viable if it has the lowest outflows. Where: A = annual inflow K = Cost of finance C = Cost of investment N = Number of years Conclusion It is evident with 50000 euros one can invest on bonds because bond is preferred than other options because of its flexibility and has higher returns. Although venture invest can yield higher returns but it is riskier thus for risk averse investors it is not the best options. References PANDEY, I. M. (2006). Financial management [with CD copy]. New Delhi, Vikas Publishing House. Read More