Investing

8.I.A

Reading

Investment options

Read the following article from 'Investment Quarterly' then work on exercises 8.I.B and 8.I.C.

Purchasing plant, machinery, management contracts, patents, and other real assets is necessary if companies are to grow and remain competitive. Investment decisions

such as these are based on the need to find assets which are worth more than they cost and which are worth more than other investments. Calculating how much a real asset is worth is often a difficult task. Unlike securities investments which are traded in highly active markets, the market for most corporate investments is relatively thin; for example, it is not often that one comes across advertisements in The Financial Times to sell an oil refinery, buy a second-hand blast furnace, or exchange a patent.

Financial managers are therefore called upon to analyse mountains of raw data supplied by armies of specialists in product design, production, marketing and so on, in order to make forecasts upon which their investment decisions will be based.

But even where a flourishing market does exist, the choice of investment is not easy as the number of investment products on the market has increased dramatically over the past few years. Before investing your money you need to analyse your resources and objectives. Determining what you are looking for in terms of income, growth, safety, liquidity and tax benefits will help you develop an efficient investment strategy.

If you are looking for a steady income from your investment the best strategy would be to choose low-risk vehicles - bank deposits, Government securities, high-grade corporate bonds and stock - which pay interest or dividends on a regular basis.

If, however, you are more interested in growth you may be better off choosing an investment which maximises the potential for capital gains. Stocks, real estate, precious metals or works of art may be the answer, although this depends very much on the prevailing economic conditions.

In general, the higher the potential for income or growth, the greater the risk of the investment. For example, the rate of return on junk bonds tends to be high, but so are the risks.

If liquidity is important to you - in other words, if you may need to convert the investment into cash soon - you should invest in something the price of which does not fluctuate too much. If not, you may have to sell when the market is down.

Stocks

Stocks can earn money in two ways: by paying dividends and through capital gains. Blue chip stocks are issued by large, well-capitalised companies that have consis-tently paid good dividends. On the other hand, stocks which offer high capital gains are more difficult to identify. The likelihood of a particular stock increasing in market value depends on a variety of factors, not least of which is the condition of the market as a whole. Stock prices tend to rise and fall as the economy expands and contracts. A 'bear' market is characterised by falling share values and generally.

occurs during recessions. A 'bull' market, on the other hand, is associated with economic booms and is characterised by rising share prices.

Corporate bonds

Corporate bonds offer income in the form of interest plus the possibility of making capital gains. Although corporate bonds are relatively safe investments, their face value can fluctuate, and may go down as well as up, thereby leading to a capital loss. However, this may not matter much to investors whose objective is to receive regular interest; the capital loss only occurs when the bond is sold and such investors may have no intention of selling.

Government securities

Federal and state governments also issue bonds which, generally speaking, carry a lower rate of interest than corporate bonds but provide advantages in terms of safety and tax advantages. In the US, the main government securities are as follows:

• Treasury bills (T-bills) are sold by the US government at a discount and redeemed at full face value at maturity, which ranges from 91 to 364 days from the date of issue. A minimum investment of $10,000 is required.

• Treasury notes and bonds have longer maturity dates than T-bills and pay a fixed rate of tax-free interest twice a year, which is generally about one percentage point less than the interest on corporate bonds. A minimum investment of $1,000 is required.

• Savings bonds are available in denominations ranging from $50 to $10,000. Although savings bonds can be sold at any time, the interest rate is higher if the holder keeps them for at least five years.

• Municipal bonds are tax-free investments issued by a town or city to help finance new public services. Many investors have become dissatisfied with municipal bonds, especially since a number of issuers defaulted on the repayments.

Mutual funds

A mutual fund is an investment company where small investors pool their money. This money is then used to acquire stocks or bonds or other financial investments. Small investors who have neither the time nor the know-how to invest rationally can benefit from the broad selection of investments which the fund is able to acquire. Mutual funds generally offer liquidity. They also offer variety and, in many cases, are tailored to specific objectives, for example, tax-exempt funds, high-growth funds, utility funds, money market funds and so on.

Commodities

Commodities are raw materials and farm produce used to produce finished goods. Producers and manufacturers need to hedge their risks and therefore follow very closely the fluctuations in the prices of the raw materials they produce or use. Contracts calling for the delivery at a given time of a set amount of these commodities are traded at Commodity Exchanges. The trade represents a shift in risk from the hedger to the speculator. Nowadays, many commodity traders are neither producers nor consumers but merely investors who will never take possession of the commodity. The commodity market is divided into 'spot trading' (for commodities that will be delivered immediately) and 'futures trading' (for commodities that will be delivered at a future date).

Financial futures

Investors in financial futures trade contracts for the delivery or acceptance of some financial instrument on a set date at a set price. Examples of financial instruments are Government securities, foreign currencies, loans, stock index futures and stock index options. Most financial futures are traded on 'the margin', a particular kind of leverage which means that the investor borrows from the broker, paying interest on the borrowed money and leaving the security with the broker as collateral.

8.I.B

Vocabulary

Defining key terms

Match the following terms with their definitions.

Terms

1. institutional investors

2. capital gains

3. speculators

4. rate of return

5. blue chip stocks

6. bull markets

7. bear markets

8. S mutual fund

9. commodities

10. spot trading

11. futures trading

12. financial futures

13. hedgers

14. leverage

15. to default

Definitions

1. Promises to buy or sell financial instruments at a future date.

2. Companies that invest money entrusted to them by others.

3. Trading in commodities that will be delivered at a future date.

4. Raw materials used in producing other goods.

5. Difference between the price at which a financial asset is sold and its original cost (assuming the price has gone up).

6. Percentage increase in the value of an investment.

7. Falling stock markets.

8. Investors who seek large capital gains through relatively risky investment.

9. Company that sells shares to the public and uses the pooled money to buy stocks, bonds, or other financial investments.

10. Equity instruments issued by large, well-established companies and paying relatively stable dividends.

11. Rising stock markets.

12. Trading in commodities that will be delivered immediately.

13. People who protect themselves from major fluctuations in prices which may lead to loss.

14. The use of borrowed funds to finance a portion of an investment.

15. Failure to pay back a debt.

8.I.C

Discussion

Where to invest

1 From your background knowledge, find examples of:

• institutional investors

• commodities

• blue-chip stocks

• real estate.

2 We are sorry to inform you that your Uncle Tom has passed away at the age of 103. You will, however, be pleased to know that he has left you $20,000 in his will. You have no immediate needs so you have decided to invest the money.

Explain to the class how you will invest the money. Justify your choice(s).

Name

Age

Marital status

Profession

Size of investment

Other information

John McGregor

25

Single

Student

$12,000

Hopes to get married in two years' time

Anne Davies

59

Widow, no children

Secretary

$25,000

Receives a small widow's pension

James Black

37

Married, two children

Engineer

$100,000

Owns some real estate and wants to diversify

Marilyn Dangerfield

45

Married, children grown up

None

$150,000

Hopes to retire to Miami when she can afford to

Martha Leclerc

52

Married, four children

Owner and managing director of a company producing saucepans

$500,000

Worried about the effects that a rise in copper prices will have on her business

8.I.D

Role play

Consulting

Work in pairs. One student will play the role of investment consultant, while the other is the client. Prepare and present a short role play in which the consultant obtains information about the client's background, resources and needs and then advises him or her on the most appropriate investment.

The following expressions may be useful:

• What can I do for you?

• What size investment were you thinking of?

• How much risk are you prepared to take on?

• I'm looking for a high-yield investment.

• I want access to my capital at short notice.

• I want to put some money by for my daughter's university education.

8.I.E

Project

Analysing the stock market

In small groups, carry out the following analysis activities.

1. Choose an industry such as banking, electronics, food, manufacturing and so on. Select five companies within that industry the stock prices of which are listed in the The New York Times or The Financial Times.

2. Read the financial section of a good newspaper over one week and keep any articles regarding your chosen industry and companies.

3. Track the daily performance of your chosen companies over one week, using the guidelines below.