INVESTMENT ENVIRONMENT

Investment environment can be defined as the existing

investment products in the market available for investor
and the markets places for transactions with these
investment products.
Thus under investment environment the main types of
investment products and the types of financial markets
should be discussed.
 INVESTMENT PRODUCTS / VEHICLES
This course focuses on the financial investments that mean the object
will be financial assets and the marketable securities in particular.
Investment in financial assets differs from investment in physical
assets in those important aspects:
Financial assets are divisible, whereas most physical assets are not.
An asset is divisible if investor can buy or sell small portion of it.
In case of financial assets it means, that investor, for example, can
buy or sell a small fraction of the whole company as investment
object buying or selling a number of common stocks.
• Marketability (or Liquidity) is a characteristic of
financial assets that is not shared by physical
assets, which usually have low liquidity.
Marketability (or liquidity) reflects the
feasibility of converting of the asset into cash
quickly and without affecting its price
significantly. Most of financial assets are easy to
buy or to sell in the financial markets.
• The planned holding period of financial assets can be
much shorter than the holding period of most physical
assets. The holding period for investments is defined as
the time between signing a purchasing order for asset
and selling the asset. Investors acquiring physical asset
usually plan to hold it for a long period, but investing in
financial assets, such as securities, even for some months
or a year can be reasonable. Holding period for investing
in financial assets vary in very wide interval and
depends on the investor’s goals and investment strategy.
Information about financial assets is often more abundant and
less costly to obtain, than information about physical assets.
Information availability shows the real possibility of the
investors to receive the necessary information which could
influence their investment decisions and investment results.
Since a big portion of information important for investors in
such financial assets as stocks, bonds is publicly available,
the impact of many disclosed factors having influence on
value of these securities can be included in the analysis and
the decisions made by investors.
Even if we analyze only financial investment there is a big
variety of financial investment vehicles. The on going
processes of globalization and integration open wider
possibilities for the investors to invest into new
investment vehicles which were unavailable for them
some time ago because of the weak domestic financial
systems and limited technologies for investment in
global investment environment.
Financial innovations suggest for the investors the new
choices of investment but at the same time make the
investment process and investment decisions more
complicated, because even if the investors have a wide
range of alternatives to invest they can’t forgot the key
rule in investments: invest only in what you really
understand. Thus the investor must understand how
investment products/vehicles differ from each other and
only then to pick those which best match his/her
expectations.
The most important characteristics of investment
vehicles on which bases the overall variety of
investment products / vehicles can be assorted
are the return on investment and the risk which
is defined as the uncertainty about the actual
return that will be earned on an investment
Each type of investment product could be characterized by
certain level of profitability and risk because of the
specifics of these financial instruments. Though all
different types of investment products can be compared
using characteristics of risk and return and the most risky
as well as less risky investment products can be defined.
However the risk and return on investment are close related
and only using both important characteristics we can really
understand the differences in investment products.
THE MAIN TYPES OF FINANCIAL INVESTMENT
PRODUCTS ARE:
• Short term investment products;
• Fixed-income securities;
• Common stock;
• Speculative investment products;
• Other investment tools.
 SHORT - TERM INVESTMENT PRODUCTS

are all those which have a maturity of one year or

less. Short term investment products/ vehicles
often are defined as money-market instruments,
because they are traded in the money market which
presents the financial market for short term (up to
one year of maturity) marketable financial assets.
The risk as well as the return on investments of short-term investment
vehicles usually is lower than for other types of investments. The
main short term investment vehicles are:
• Certificates of deposit;
• Treasury bills;
• Commercial paper;
• Bankers’ acceptances;
• Repurchase agreements.
CERTIFICATE OF DEPOSIT
is debt instrument issued by bank that indicates a specified
sum of money has been deposited at the issuing
depository institution.
Certificate of deposit bears a maturity date and specified
interest rate and can be issued in any denomination.
Most certificates of deposit cannot be traded and they
incur penalties for early withdrawal. For large money-
market investors financial institutions allow their large-
denomination certificates of deposits to be traded as
negotiable certificates of deposits.
TREASURY BILLS (ALSO CALLED T-BILLS)
are securities representing financial obligations of the
government. Treasury bills have maturities of less than
one year.
They have the unique feature of being issued at a discount
from their nominal value and the difference between
nominal value and discount price is the only sum which
is paid at the maturity for these short term securities
because the interest is not paid in cash, only accrued.
The other important feature of T-bills is that they are treated
as risk-free securities ignoring inflation and default of a
government, which was rare in developed countries, the
T-bill will pay the fixed stated yield with certainty.
But, of course, the yield on T-bills changes over time influenced by
changes in overall macroeconomic situation. T-bills are issued on an
auction basis. The issuer accepts competitive bids and allocates bills
to those offering the highest prices. Noncompetitive bid is an offer
to purchase the bills at a price that equals the average of the
competitive bids. Bills can be traded before the maturity, while their
market price is subject to change with changes in the rate of interest.
But because of the early maturity dates of T-bills large interest
changes are needed to move T-bills prices very far. Bills are thus
regarded as high liquid assets.
COMMERCIAL PAPER
is a name for short-term unsecured promissory notes issued by
corporation. Commercial paper is a means of short-term borrowing
by large corporations. Large, well-established corporations have
found that borrowing directly from investors through commercial
paper is cheaper than relying solely on bank loans.
Commercial paper is issued either directly from the firm to the investor
or through an intermediary. Commercial paper, like T-bills is issued
at a discount.
The most common maturity range of commercial paper is
30 to 60 days or less. Commercial paper is riskier than T-
bills, because there is a larger risk that a corporation will
default. Also, commercial paper is not easily bought and
sold after it is issued, because the issues are relatively
small compared with T-bills and hence their market is
not liquid.
BANKER‘S ACCEPTANCES
are the vehicles created to facilitate commercial trade transactions.
These vehicles are called bankers acceptances because a bank
accepts the responsibility to repay a loan to the holder of the vehicle
in case the debtor fails to perform. Banker‘s acceptances are short-
term fixed-income securities that are created by non-financial firm
whose payment is guaranteed by a bank. This short-term loan
contract typically has a higher interest rate than similar short –term
securities to compensate for the default risk. Since bankers’
acceptances are not standardized, there is no active trading of these
securities.
REPURCHASE AGREEMENT
(often referred to as a repo) is the sale of security with a
commitment by the seller to buy the security back from
the purchaser at a specified price at a designated future
date. Basically, a repo is a collectivized short-term loan,
where collateral is a security. The collateral in a repo
may be a Treasury security, other money-market
security. The difference between the purchase price and
the sale price is the interest cost of the loan, from which
repo rate can be calculated.
Because of concern about default risk, the length of
maturity of repo is usually very short. If the agreement is
for a loan of funds for one day, it is called overnight
repo; if the term of the agreement is for more than one
day, it is called a term repo.
A reverse repo is the opposite of a repo. In this transaction a
corporation buys the securities with an agreement to sell
them at a specified price and time. Using repos helps to
increase the liquidity in the money market.
FIXED-INCOME SECURITIES
are those which return is fixed, up to some redemption date
or indefinitely. The fixed amounts may be stated in
money terms or indexed to some measure of the price
level. This type of financial investments is presented by
two different groups of securities:
• Long-term debt securities
• Preferred stocks.
 LONG-TERM DEBT SECURITIES

can be described as long-term debt instruments representing the

issuer’s contractual obligation. Long term securities have
maturity longer than 1 year. The buyer (investor) of these
securities is landing money to the issuer, who undertake
obligation periodically to pay interest on this loan and repay
the principal at a stated maturity date. Long-term debt
securities are traded in the capital markets. From the investor’s
point of view these securities can be treated as a “safe” asset.
But in reality the safety of investment in fixed –income
securities is strongly related with the default risk of an issuer.
The major representatives of long-term debt securities are bonds, but
today there are a big variety of different kinds of bonds, which
differ not only by the different issuers (governments, municipals,
companies, agencies, etc.), but by different schemes of interest
payments which is a result of bringing financial innovations to the
long-term debt securities market
As demand for borrowing the funds from the capital markets is
growing the long-term debt securities today are prevailing in the
global markets. And it is really become the challenge for investor to
pick long-term debt securities relevant to his/ her investment
expectations, including the safety of investment.
PREFERRED STOCKS
are equity security, which has infinitive life and pay dividends. But
preferred stock is attributed to the type of fixed-income securities,
because the dividend for preferred stock is fixed in amount and
known in advance. Though, this security provides for the investor
the flow of income very similar to that of the bond. The main
difference between preferred stocks and bonds is that for preferred
stock the flows are for ever, if the stock is not callable.
The preferred stockholders are paid after the debt securities
holders but before the common stock holders in terms of
priorities in payments of income and in case of
liquidation of the company . If the issuer fails to pay the
dividend in any year, the unpaid dividends will have to
be paid if the issue is cumulative. If preferred stock is
issued as noncumulative, dividends for the years with
losses do not have to be paid.
Usually same rights to vote in general meetings for
preferred stockholders are suspended. Because of
having the features attributed for both equity and
fixed-income securities preferred stocks is known
as hybrid security. A most preferred stock is issued
as noncumulative and callable. In recent years the
preferred stocks with option of convertibility to
common stock are proliferating.
 THE COMMON STOCK
is the other type of investment vehicles which is one of most
popular among investors with long-term horizon of their
investments. Common stock represents the ownership interest
of corporations or the equity of the stock holders. Holders of
common stock are entitled to attend and vote at a general
meeting
of shareholders, to receive declared dividends and to receive
their share of the residual assets, if any, if the corporation is
bankrupt. The issuers of the common stock are the companies
which seek to receive funds in the market and though are
“going public”.
The issuing common stocks and selling them in the
market enables the company to raise additional
equity capital more easily when using other
alternative sources. Thus many companies are
issuing their common stocks which are traded in
financial markets and investors have wide
possibilities for choosing this type of securities
for the investment.
 SPECULATIVE INVESTMENT PRODUCTS/
VEHICLES
following the term “speculation” could be defined as
investments with a high risk and high investment return.
Using these investment vehicles speculators try to buy low
and to sell high, their primary concern is with anticipating
and profiting from the expected market fluctuations. The
only gain from such investments is the positive difference
between selling and purchasing prices. Of course, using
short-term investment strategies investors can use for
speculations other investment vehicles, such as common
stock, but here we try to
accentuate the specific types of investments which are more
risky than other investment vehicles because of their
nature related with more uncertainty about the changes
influencing the their price in the future.
Speculative investment vehicles could be presented by these
different vehicles:
• Options;
• Futures;
• Commodities, traded on the exchange (coffee, grain
metals, other commodities);
OPTIONS
Options are the derivative financial instruments. An options
contract gives the owner of the contract the right, but not
the obligation, to buy or to sell a financial asset at a
specified price from or to another party. The buyer of the
contract must pay a fee (option price) for the seller.
There is a big uncertainty about if the buyer of the
option will take the advantage of it and what option price
would be relevant, as it depends not only on demand and
supply in the options market,
but on the changes in the other market where the financial
asset included in the option contract are traded. Though,
the option is a risky financial instrument for those
investors who use it for speculations instead of hedging.
Options are the derivative financial instruments. An
options contract gives the owner of the contract the right,
but not the obligation, to buy or to sell a financial asset
at a specified price from or to another party
The buyer of the contract must pay a fee (option price) for
the seller. There is a big uncertainty about if the buyer of
the option will take the advantage of it and what option
price would be relevant, as it depends not only on
demand and supply in the options market, but on the
changes in the other market where the financial asset
included in the option contract are traded. Though, the
option is a risky financial instrument for those investors
who use it for speculations instead of hedging.
FUTURES
Futures are the other type of derivatives. A future contract
is an agreement between two parties than they agree tom
transact with the respect to some financial asset at a
predetermined price at a specified future date. One party
agree to buy the financial asset, the other agrees to sell
the financial asset. It is very important, that in futures
contract case both parties are obligated to perform and
neither party charges the fee.
There are two types of people who deal with options (and futures)
contracts:
speculators and hedgers. Speculators buy and sell futures for the sole
purpose of making a profit by closing out their positions at a price
that is better than the initial price. Such people neither produce nor
use the asset in the ordinary course of business.
In contrary, hedgers buy and sell futures to offset an otherwise risky
position in the market. Transactions using derivatives instruments
are not limited to financial assets.
There are derivatives, involving different commodities (coffee, grain,
precious metals,
and other commodities). But in this course the target is on
derivatives where
underlying asset is a financial asset.
Other investment tools:
• Various types of investment funds;
• Investment life insurance;
• Pension funds;
• Hedge funds.
INVESTMENT COMPANIES/ INVESTMENT FUNDS.
They receive money from investors with the common objective of pooling the
funds and then investing them in securities according to a stated set of
investment objectives. Two types of funds:
• open-end funds (mutual funds) ,
• closed-end funds (trusts).
Open-end funds have no pre-determined amount of stocks outstanding and
they can buy back or issue new shares at any point. Price of the share is not
determined by demand, but by an estimate of the current market value of
the fund’s net assets per share (NAV) and a commission.
Closed-end funds are publicly traded investment
companies that have issued a
specified number of shares and can only issue
additional shares through a new public issue.
Pricing of closed-end funds is different from the
pricing of open-end funds: the market price can
differ from the NAV.
INSURANCE COMPANIES
Insurance Companies are in the business of assuming the
risks of adverse events (such as fires, accidents, etc.) in
exchange for a flow of insurance premiums.
Insurance companies are investing the accumulated funds
in securities (treasury bonds, corporate stocks and
bonds), real estate. Three types of Insurance Companies:
life insurance; non-life insurance (also known as
property-casualty insurance) and reinsurance.
During recent years investment life insurance
became very popular
investment alternative for individual investors,
because this hybrid investment product allows to
buy the life insurance policy together with
possibility to invest accumulated life insurance
payments or lump sum for a long time selecting
investment program relevant to investor‘s future
expectations.
PENSION FUNDS

Pension Funds are an asset pools that accumulates

over an employee’s working years and pays
retirement benefits during the employee’s
nonworking years. Pension funds are investing
the funds according to a stated set of investment
objectives in securities (treasury bonds,
corporate stocks and bonds), real estate.
HEDGE FUNDS
Hedge funds are unregulated private investment
partnerships, limited to institutions and high-net-worth
individuals, which seek to exploit various market
opportunities and thereby to earn larger returns than are
ordinarily available. They require a substantial initial
investment from investors and usually have some
restrictions on how quickly investor can withdraw their
funds. Hedge funds take concentrated speculative
positions and can be very risky.
It could be noted that originally, the term “hedge” made
some sense when applied to these funds. They would by
combining different types of investments, including
derivatives, try to hedge risk while seeking higher return.
But today the word “hedge’ is misapplied to these funds
because they generally take an aggressive strategies
investing in stock, bond and other financial markets
around the world and their level of risk is high.
QUESTIONS?