Brief Overview on different types of Investments
In a financial markets, Assets and Liabilities valuation is
important especially where the business is long term in nature.
Actuary work majorly revolves around estimation of liabilities.
But there are various measures through which you can value your assets. But today
we will discuss what are the different types of investments in which a company
can invest in.
Money Market
·
Short term instrument
·
Usually preferred by the investor who needs
liquidity in there portfolio
·
Returns are stable but very low
·
It is usually a favourable investment when
investors are expecting a devaluation of their country’s currency. For ex, you
are from India and currently 1$ = 65Rs. now you invest 100$ (i.e. Rs. 6500) in
USA and you are expecting a depreciation of INR with respect to USD suppose 1$
= 70Rs. Then the value of investment will be Rs.7000 (i.e. 70*100$).
·
Expected weakening of domestic currency will
make investment in overseas money market instruments attractive.
Bonds
·
First of all you should know that there are
various types of bonds for ex:
o
Corporate bonds – issued by companies
o
Government bonds – Issued by Government (usually
risk free if country is developed)
o
Index linked bonds – where returns are linked
with an index
o
Conventional bonds – these are fixed interest
bonds
o
Callable bonds - Callable bonds are those which
can be repaid by borrower at any time.
o
Puttable bonds – are those where investor can
demand repayment at any time
·
Insurance companies most favourite investment
usually is bonds. For ex, X is an insurance company that pays out annuity to
policyholders say for 10 years for Rs. 1,00,000 each per annum. Then Insurer
will try to buy bonds that will provide coupon amount of atleast Rs. 1,00,000 +
Expenses cost + Expected profit per annum say for 10 years. That’s how company
match there liabilities outgo with assets income.
·
Yields are more than money market instruments
but risk attached is also more such as:
o
Default risk – what if issuer default on the coupon
or/and redemption payment
o
Liquidity risk – not easily convertible into cash
at a certain rate
o
Marketability risk – not able to buy /sell
easily
·
These can be available for short, medium and
long term. Risks inherent in government bonds are low as compared to corporate
bonds
Equities
·
Now these are more risky as compare to bonds.
·
You can make a lot of diversification in terms
of equities such as:
o
On the basis of different equity industries such
as in Bank stocks, Pharma stocks
o
On the basis of different companies within same
industry. For ex, HDFC bank , AXIS bank etc.
o
Overseas equities
·
They provide real return and this asset is long
term in nature. Technically term of this asset class is perpetuity in nature.
Property
·
Now property investment can be direct as well as
indirect. For ex, you purchased a house and you want to sell it in future, then
its’s a direct investment. Indirect property investment can be such as you
invested in a stock that deals in property business such as DLF or any real
estate company.
·
With respect to direct property there are a lot
of risks such as:
o
Risk of voids (i.e. you have used that property
for tenancy and there is no tenant)
o
Risks of political interference
o
Risk of obsolescence and need for refurbishments
o
Security will depend on the quality of tenant
·
Investor expects higher return to compensate for
lower marketability
·
Capital values are more volatile in long term
and stable in short term.
·
Each property is unique, it makes it
harder to value
·
Rental yields are often lower than bond yields
due to prospect of capital gain
Collective Investment Schemes
·
Loosely speaking!! It’s a mutual fund
·
Collective investment schemes provide structures
for management of investments on a grouped basis.
·
There are a lot of advantages especially for an
investor who does not have enough knowledge of investments or who does not have
enough time to track there portfolio
Derivative
·
Highly risky investment but there are 2 major
uses of derivatives i.e.
o
Hedging – to reduce the risk. For ex, I am
concerned about the decrease in the value of my equity portfolio so I will
cover my downside risk by purchasing a put option
o
Speculation – to enhance returns but it comes
with a more risk
·
Various types of derivatives are:
o
Options
o
Futures
o
Forwards
o
Swaps (Interesting instrument used to cover the longevity
risk is Longevity swaps)
Overseas Investments
·
It is not a specific type but it helps in
diversification and some major uses.
·
Suppose your liabilities are denominated in
overseas currency, then its better to invest in same currency to match your
liabilities with your assets
·
Sometimes foreign currency market is inefficient
then investor can expect higher return by exploiting inefficiencies.
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