The Investment Environment

INVESTMENT ENVIRONMENT

The term investment refers to exchange of cash wealth into some tangible wealth.  The cash wealth here refers to the cash (savings) which an investor has and the term tangible wealth refers to the assets the investor acquires by sacrificing the money wealth. By investing, an investor commits the present funds to one or more assets to be held for some time in expectation of some future return in terms of interest or capital gain. Investment can be defined as commitment of funds that is expected to generate additional money.

The term Investment Environment encompasses all types of investment opportunities and the market structure that facilities buying and selling these investments. Different types of securities, institutional set-up and the market intermediaries are the components of investment environment.

The Investment Environment

1. Introduction to Securities:

Security analysis and portfolio management are hard work, requiring discipline and patience, and the work is not always rewarded by exceptional returns. The handsome returns have been reaped in the market by a variety of methods ranging from sheer genius to the occult. The unfortunate thing about most of these techniques is that they are difficult to duplicate consistently by everyone. Often they just cannot be verbalised in a way that permits systematizing.

Various types of securities are traded in the market. Broadly securities represent evidence to property right. Security provides a claim on an asset and any future cash flows the asset may generate. Commonly we think of securities as shares and bonds. According to the Securities Contract Regulation Act 1956, securities include shares, scrips, stocks, bonds, debentures or other marketable like securities of any incorporated company or other body corporate, or government. 

Securities are classified on the basis of return and the source of issue. On the basis of income they may be classified as fixed or variable income securities. In the case of fixed income security, the income is fixed at the time of issue itself. Bonds, debentures and preference shares fall into this category. Sources of issue may be government, semi government and corporate. The incomes of the variable securities vary from year to year. Dividends of the equity shares of companies can be cited as an example for this. Corporate generally raises funds through fixed and variable income securities like equity shares, preference shares and debentures.

2. Markets for Securities

Securities market is a broad term embracing a number of markets in which securities are bought and sold. In this chapter the function, structure, and operations of major types of markets will be discussed, including how an individual Investor goes about the business of placing any order to buy or sell, how the order is executed, and the process of settling the payment and transfer costs.

One way in which securities markets may be classified is by t types of securities bought and sold there. The broad classification is based upon whether the securities are new issues or are already outstanding and owned by Investors. New issues are made available in primary markets; securities that are already outstanding and owned by Investors are usually bought and sold through the secondary markets. Another classification is by maturity: Securities with maturities of one year or less normally trade in the money market; those with maturities of more than one year are bought and sold in the capital of market. 

The existence of markets for Securities is of advantage to both issuers and Investors. As to their benefit to issuers, securities markets assist business and government in raising funds. In a society with private ownership of the means of production and distribution of goods and services, services must be directed toward investment in industries where capital is most productive. Government must also be able to borrow for public improvements. Market mechanism make possible the transfer of funds from surplus to deficit sectors, efficiently and at low cost.

Investors also benefit from market mechanisms. If Investors could not resell securities readily, they would be hesitant to acquire them in the first place, and such reluctance would reduce the total quantity of funds available to finance industry and government. Those who own Securities must be assured of a fast, fair, orderly, and open system of purchase and sale at known prices.

3. Costs of Investing in Securities

Investment and speculation are not carried on without cost. There are direct costs, such as commissions, interest paid on borrowed funds, and taxes, and indirect costs, such as federal estate and gift taxes. Finally, there are implicit costs, such as the investor's team in seeking out and evaluating investment opportunities and deciding what to sell , as well as the implicit cost of money tied up in an investment. 

These various direct transaction costs are incurred in trading of Securities. We shall attempt to provide general relationships between tax law, commission structure, and the investment process. Investors and speculators should appreciate the complexities of the transaction-cost environment and know when to seek expert advice -- or at the very least, take transaction costs into account when contemplating an investment or speculative action.

  a) Direct commissions and Transfer Taxes: 

When an investor buys and sells securities, his transaction costs involve direct costs stemming from the transaction - brokerage commission and transfer taxes - and costs stemming from the completion of a transaction cycle - buy and a sell order in the same security. These latter costs will be discussed in conjunction with the personal income tax. Direct transaction costs can cut deeply into profits. In fact, if the profit is relatively small, these costs can change it into a net loss. Such a situation is most likely to occur with a speculator who is constantly switching positions in order to capitation minor price fluctuations.

  b) Federal personal income tax: 

The major concern in discussing federal taxes will be their impact upon individuals as Investors. First, let us briefly note the general procedure for tax calculations; then we shall see how the amount of tax is affected by dividends, capital gains provision, and various tax shelters that are available under the current tax laws.

  c) Other cost of investing:

Other cost of investing are often overlooked by Investors. First, there are opportunity costs. Investors spend time analysing possible investments and then spend time monitoring and worrying about them after they are made. These are very real opportunity costs, because the investor is sacrificing the satisfaction he could receive or money he could earn in alternative activities in which he could engage if he were not investing or worrying. Further, when money is committed to an investment, the investor with limited capital forgoes alternative returns that he would earn elsewhere, such as interest earned on a savings bank account. In addition, when securities are bought on margin, interest is paid on the borrower funds. Even though the interest is deductible on the investor's income and tax return - subject to limitations - this too should be treated as a very real cost of investing.