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Investment Game

Investment Game:

The funds at the disposal of a firm may be fully used for its own requirements or a portion of them may be placed outside the business. The funds placed outside its own normal business operations by a firm can be termed as investments. Thus, investments represent surplus funds of a firm, which are not immediately needed by the business.

Investments usually comprise of legal claims of various types called Securities. They include Central and State Government bonds, debentures or bonds of local government, shares and debentures of public limited companies etc.

Some institutions like banks acquire approved securities to fulfill the statutory liquidity requirements. Insurance companies and public utilities also invest a large portion of their funds in outside securities. Investment trusts like Unit Trust of India may have almost all of their funds in the form of securities.

Even other business units invest their surplus funds outside their business depending on their liquidity.

Planning an Investment:

A financial planners role is to develop, implement and monitor a long term investment strategy to help clients achieve their objectives. But first, the clients unique requirements and comfort zone must be understood. An existing portfolio must be evaluated to determine if its characteristics and features suit the client. A portfolio should be designed by allocating a certain percentage of the assets to debt (interest generating) investments and a certain percentage to equity (growth oriented) investment a vital process called allocation.

investment planning should be viewed from a long term perspective and it should have long term objectives. Once these objectives are set, they should be changed only to reflect a significant alteration in a clients situation such as impending retirement or divorce not an emotional reaction to short term fluctuations in financial markets.

A planner familiar with the steps can use them in the order that seems most appropriate to each clients situation. Despite high levels of technology and expertise applied to investment strategy, investment planning remains an art, not a science.

Nature of investments, as an Asset:

Investments may be classified as a fixed asset or a current asset, depending on the intention with which they are acquired. If the investments are bought and sold frequently with the intention of making short term profits, they are trading investments or current investments. If investments are purchased with the intention of retaining for longer periods and the dividend or interest income is intended to be received for some years, the investments are long term investments or fixed investments.

The long term investments are shown at cost in the balance sheet and any fluctuations in the market price are usually ignored. The trading investments are shown in the balance sheet at cost or market price whichever is lower, on the basis of the convention of conservatism.

Types of Securities:

The securities usually purchased as investments can be classified as follows, on the basis of Regularity of income.

1. Fixed income bearing securities

Securities which carry a fixed rate of return payable periodically like government bonds, debentures of companies can be placed under this category. Investments of sinking fund are usually made in such securities.

2. Variable income bearing securities

Securities like shares do not carry specific rates of return. The companies which issued the shares may not pay dividend if profits are inadequate. The dividend paid varies from year to year.

Purchase and Sale of Investments:

Investments in the form of securities can be purchased in Primary Market or Secondary Market. Purchase in primary market involves applying to the institutions which offer securities and getting allotment. Purchase in secondary market involves purchase through stock exchanges or from other sources through brokers, bankers, etc. Sale of investment is usually done in secondary market through brokers or bankers.

Purchase or sale of investments may be at par or at premium or at discount. Par value is the nominal value or face value of a security. If the amount paid is more than face value, the excess amount is the premium. If the amount paid is less than the face value, the difference is the discount.

There may be expense of acquisition like brokerage, stamp duty, transfer fees etc, which should be added to the cost of the investments. Thus investment must be recorded at the purchase price suitably adjusted for expenses of acquisitions. Similarly, when investments are sold, the sale proceeds should be reduced to the extent of the expenses relating to sale like brokerage and other incidental expenses.

It should be noted that the capital cost of investments along with the acquisition expenses should be treated as cost of investment; but any amount paid to the seller of securities towards interest or dividend should not be a part of cost of investments. Similarly, when investments are sold, the interest or dividend received along with sale price should be excluded for computation of profit or loss on sale of the investments.

Cum Interest and Ex Interest Quotations:

Interest is usually paid once in six months on all fixed interest bearing securities like government bonds and debentures. If purchase or sale takes place on the dates of interest payment, the price quoted is exclusively for the securities. However, if the investment transactions take place on any other date, the seller must receive not only the value of the securities sold but also the interest till that date from previous interest payment date. If the price quoted includes the interest also, it is cum-interest price. If the price does not include interest it is ex-interest price. Cum-interest price is the total amount payable to the seller. From the cum-interest price interest should be subtracted to find the amount paid for the securities. Ex-interest price is the amount payable for the securities. Interest should be added to the ex-interest price to find the total amount payable to the seller.

Capital cost of investment or real price = cum-interest price + acquisition costs interest or

Ex-interest price + acquisition costs.

Investment in Equity Shares

Investment account for equity shares acquired has to be maintained, keeping the following special features in mind:

1. Cost of investment includes the amount paid for the shares, brokerage, stamp duty and transfer fees etc.

2. Bonus shares may be received as per the terms of such issue. Bonus increases the number of shares held, without involving any additional cash payment. As a result, the average cost of the shares reduces. In the absence of specific instruction, weighted average cost is used when shares are sold to find out the loss or profit on sale.

Rights Issues

Holders of equity shares may be allowed to subscribe for further shares of a company on rights basis. Each shareholder can pay the required amount as per the terms of the issue and get the shares for which he is eligible on rights basis.

The Right can also be renounced by a shareholder in favor of somebody else who can buy the rights shares. The shareholder receives some amount as consideration for the renouncement.

Cum Dividend Purchase

Unlike fixed income bearing securities, the dividend amount cannot be exactly calculated till it is received. So, the entire amount paid should be shown as cost of purchase.

Related Topics

1. Calculation of Return on Investment

2. Investment Criteria

3. Portfolio of Marketable Securities

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