Types of Investment Assets

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1 Types of Investment Assets Cash and Equivalents, and Money Market Securities The most widely known and used type of cash-equivalent instruments are savings accounts and time deposits at banks and finance companies. Because of their low-risk nature, the disadvantage with such deposits is that they are low-yield in return. Time deposits also do not provide as a good investment hedge as the specified interest offered at inception does not respond to changes in market interest rates. Money market instruments are low-risk, highly liquid, short-term debt instruments issued by governments, financial institutions and corporations. The minimum denominations of these securities are relatively large and the size of the transactions can be substantial. The maturities of money market securities range from one day to one year and are often less than 90 days. The instruments traded in the money market include treasury bills, commercial papers, banker s acceptances, negotiable certificates of deposits and repurchase agreements. Investment in money market instruments generally increases when investors are uncertain about prospects in other classes of investments. Investors will increase their holding of money market instruments in an investment portfolio, when stocks and bonds are expected to perform poorly, such as when interest rates are expected to be on an upward trend. Stocks or Equities Among the financial assets available for investment, equity securities constitute a major asset class. Despite the volatility associated with equity investments, the potential for substantial capital gains remains a major draw among investors. Common Stocks Common stocks represent ownership shares in a corporation. Shareholders stand to profit when the company profits. Investors buy equities for both capital appreciation and dividend income. Ordinary dividends are not annual guaranteed payments, but the amount and frequency can vary depending on the performance and dividend policy of the company. Common stock offers the greatest rewards but also the greatest risks of all investment securities over long periods of time. Preferred Stocks Preferred stocks is considered a hybrid security because it resembles both fixed-income and equity instruments. It is regarded less risky than a common stock because the dividends are specified and must be paid before a common stock dividend can be paid. However, bondholders still have priority in being paid in case of liquidation. The issuer can also forgo paying the preferred dividend if earnings are insufficient. Unlike ordinary shareholders,

2 preferred shareholders do not enjoy the benefits of rising dividends and capital appreciation as the company prospers. Common stock can be classified under the following categories: Blue Chips Stocks They are high-grade, investment-quality issues of major companies, which have long and unbroken records of earnings and dividend payments. The term is used to describe the common stock of large, well-established, stable and mature companies of great financial strength. Growth Stocks They are stocks of companies whose sales, earnings and market share are growing faster than the economy and the average for the industry. They normally pay relatively small dividends as earnings are retained for expansion purposes. Income Stocks They are stocks of companies that pay higher than average dividend yield. These may comprise of mature companies, which are able to generate large cash flow that is not required for expansion purposes. Cyclical Stocks They are stocks of companies whose earnings and prices fluctuate with the business cycle and are accentuated by it. Defensive Stocks Also known as recession-proof stocks as there are a high likelihood that earnings from these stocks will be able to withstand an economic downturn or uncertainty. Usually issued by companies provide consumer necessities, such as food or pharmaceuticals. One of the most widely reported and used valuation ratio for stocks is the Price-Earnings Ratio (P/E ratio). It is calculated as the ratio of the current market price to the firm s earnings per share. Also known as the earnings multiplier, it is an indication of how much the market is willing to pay per dollar of earnings. Growth stocks would typically sell at high multiples compared to the average stock because of their expected higher earnings growth. Fixed Income Securities Also known as debt securities or bonds, they are a form of borrowings by the issuers. As an investor, you are lending a certain amount of money (principal) to the issuer. In return, the issuer agrees to make periodic interest payments (coupons) and to return the principal at the maturity date. Bond issues of governments and businesses typically are quality rated by rating agencies to assess the likelihood that the issuer will default on the timely payment of coupon and/ or principal. The lower the quality rating, the greater will be the risk of default, and the higher

3 will be the coupon rate that the investor will expect to earn. The higher return reflects the risk premium which represents the reward for the higher risk undertaken by the investor. Bonds and other forms of fixed income securities can be good investments for investors interested in having the amount of monies at maturity made known to them and also receive a steady stream of income. In addition, fixed income securities are a versatile investment vehicle. They can be sued conservatively by those who primarily seek high current income to supplement other income sources. Alternatively, they can be used aggressively for trading purposes by those who actively seek capital gains. Unit Trusts A unit trust is a legal vehicle set up to pool the financial resources of small investors and invests the funds in securities by professional fund managers. It is based on the simple principle of dividing a fund into equal portions referred to as units. Each unit represents exactly the same proportion of value of the shares held by the trust. For example, if a unit trust s investments are worth $15 million and there are 5 million units in issue, each will be worth $3. Most unit trusts investments are valued daily, and the previous day s valuation prices will be published each day so as to serve as the opening dealing prices. The managers neither hold the investments nor issue or redeem units. Instead, the trustee will create new units when there are new purchases and redeem units when the unit holders liquidate their holdings. Advantages of Investing in Unit Trusts: Diversification One of the largest advantages of investing in unit trust is the diversification provided. By pooling investors money, companies enable shareholders to hold fractional shares of many different securities. This diversified portfolio of securities hence shield investors from large losses. Small Capital Outlay The initial investment outlay can range from $1,000 to $5,000, which is an affordable amount to an individual investor. Furthermore, unit trusts will allow investors to invest in a portfolio of stocks and bonds with this amount, which would otherwise be outside the reach of an average investor if not for the pooling of financial resources. Professional Management Most investment companies have full-time staffs of security analysts and portfolio managers who are trained in investments. They are hence prompt in reacting to the investment environment and can manage their fund by responding accordingly.

4 Unit trusts are also classified in terms of the assets they invest in. Below are three types of funds classification: Bond Funds Bond funds invest in fixed-income securities. There are corporate bond funds, convertible bond funds, and high-yield bond funds and so on. Bond funds typically pay periodic dividends that include interest payments on the fund s underlying securities along with periodic realized capital appreciation. Equity Funds Equity funds invest only in equity securities. These equity funds can be concentrated solely on the securities of firms in a particular industry or sector. Examples include gold funds and technology funds. Others provide a convenient means for holding the securities of firms in a particular country. Funds may also have a regional orientation, such as BRIC funds and Emerging Europe funds, while others may be globally invested. Money Market Funds Hold short-term fixed income instruments such as treasury bills and commercial paper. They seek to limit exposure to losses due to credit, market, and liquidity risks. Because of the large denominations involved in dealing directly, these funds provided an avenue for investors seeking competitive money market rates. Some unit trusts may offer regular savings plans (RSPs) whereby a fixed sum of money is invested in the unit trust at regular intervals. This dollar-cost averaging strategy allows investors to overcome the price volatility in the unit trust. Real Estate Investments There are many forms of real estate ownership available to investors. One such form is the purchase of property directly, either as an individual, or as a managing partner in a partnership. Another way that requires less active management by the investor is to own shares in a Real Estate Investment Trust (REIT). Property is a good investment for the following reasons: (i) Inflation Hedge Property values and the income from properties tend to rise to keep pace with inflation and (ii) Capital Appreciation Real estate values tend to appreciate over time, although not guaranteed. However, some disadvantages of investing in property is that it requires high transaction costs due to brokerage commissions, legal fees and stamp duties. Investing in real estate is hence not advisable for investor who needs liquidity. Real estate is usually not as liquid as other type of investments such as stocks and bonds, and are hence seen as long-term investments.

5 Financial Derivatives Financial derivatives are financial assets in which the values are derived from or depend on some other assets (such as equity, foreign exchange, commodities, bonds and others) Options A formal contract between a seller and the buyer on the right (but not the obligation) to buy-and-sell (or sell-and-buy) a specific property or a fixed-quantity of a commodity, currency, or security at a pre-set strike price on or up to the expiration date. The buyer generally pays a premium for the contract, thus obtaining investment leverage. The most significant advantage of options is that it limits the investor s exposure to risk, since the only amount of money to be lost is the purchase price if the option is not exercised. Warrants They are a special type of call option issued by a corporation that gives the holder the right to acquire equity at a specified price and within a designated time period. An investor can buy a warrant as a way to establish an exposure to a share without a large initial capital outlay, or can sell the warrant at a profitable price when the price of the underlying share goes up. Futures A standardized, transferable, exchange-traded contract between two parties-futures contract between two parties that requires delivery of a commodity, currency, bond or stock index at a specific price on a specific future date. Swaps A derivative in which two counterparties exchange certain benefits (cash flows) of one party s financial instrument for those of the other party s financial instrument. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated. Swaps can be used to hedge certain risks, such as interest rate risk, or to speculate on changes in the expected direction of prices of underlying securities. Yvonne Chua

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