Topic 1 X Investment

Markets

LEARNING OUTCOMES

By the end of this topic, you should be able to:

1. Describe the concept of investment;
2. Distinguish between financial assets and real assets;
3. Differentiate the four types of financial investments;
4. Evaluate the types of financial markets;
5. Assess the major participants in the financial markets; and
6. Conclude the types of information needed for financial decision
making.

X INTRODUCTION
What do the Bursa Malaysia, the New York Stock Exchange, the Hong Kong
Stock Exchange and the Tokyo Stock Exchange have in common? They are
all financial markets where firms, households and governments borrow and lend
funds. This topic will provide an understanding of the investment environment
within the local and international financial markets. What makes up the
investment environment will be explained by examining how the financial
markets are classified, the types of securities that are being traded, the players
involved in financial securities trading and the relevant regulatory bodies
responsible for overseeing the smooth functioning of the investments activities.
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1.1 DEFINITION OF INVESTMENT

Investment actually refers to current commitment of present resources mainly

money, in the hope of gaining future benefits.

The commitment involves setting aside present resources that would allow the
increase in value of the resources in the future. Hence, it requires us to postpone
present consumption and wait for some time in the future. For example, you
might set aside a sum of money to purchase shares today instead of spending it
on a brand new car. What you are doing is to postpone your spending today and
commit your money in the investment of shares. It is done in the hope of gaining
future benefits such as dividends earned or an increase in share price.

SELF CHECK 1.1

What do you understand by investment? Does it refer to the money kept in

your fixed account or to property bought for long term investment? What
about the shares that you bought from the financial market?

1.2 TYPES OF INVESTMENT

Before we proceed with further discussion about various types of investment, let
us ponder over our earlier explanation of the definition of investment. Based on
the definition, funds deposited in fixed accounts, property bought for long term
investment and shares purchased from the share market are all considered
as investment. But, what types of investment are they?

To help you understand the various types of investment, let us look at the
following example.

Let us say you have just won the lottery and you are not sure what to do with the
money. You could use the money to buy a shop lot and the rent collected in the
future will allow you to travel. Alternatively, you could avoid the risk of not
being able to collect your rent from your tenant or having to maintain the
building, by investing your winnings in the shares of a public listed company.
Through this investment, you will be entitled to receive dividends when the
company makes profits. In addition to that, you have the opportunity to earn in
the investment if the price of the share appreciates in the future.
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In the above example, we saw that there are two types of assets that we could
invest in:
Ć Real assets
Ć Financial assets

Investment in the shop lot is an example of an investment in real assets. The shop
lot is an asset, a premise used as an office space or business dwelling. Hence, the
capacity of the asset to generate tangible services is the main feature of a real
asset.

Investment in shares or any securities represents a claim on the real assets of a

company. Investments in shares of a public listed company enable the investor to
have a claim over the real assets of the company. The claim can be in the form of
dividends paid out of the profits earned.

The above example illustrates how real assets can generate net income to the
economy. A financial asset however, can simply be regarded as the allocation of
income or wealth among investors. Investors can choose between consuming
their wealth today or investing for the future. A wide variety of choices can be
made in securities available in the market.

When an investor buys the shares from a company, proceeds from the sale
will be utilised by the firm to purchase real assets such as machinery, equipment,
inventories and other real assets in order to generate profits for the firm. Hence,
the ultimate return of the company will come from the income that is produced
by the real assets that were financed by the issuance of the securities. The profits
are then distributed in the form of dividends to the shareholders.

1.3 TYPES OF FINANCIAL INVESTMENTS

Financial assets can be categorised into four distinct types of financial
investment according to the characteristics of the claims:
Ć Debt Claims
Ć Equity or Residual Claims
Ć Derivative Claims
Ć Hybrid Securities

Now, let us look at the different types of claims found in securities.

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(a) Debt Claims

Security in the form of debt is normally referred to as bonds. It entitles the

investor (bondholder) to a specific amount of payment in the form of interest
and principal irrespective of whether the firm generates income or not.
Payments of interest rates for this type of debt security depends on the type
of security issued.

A bond can provide returns in the form of a coupon rate which is determined at
the time of issuance. The cash received in the form of coupon payment is the
coupon rate over the par value of the bond. Bonds have a maturity period which
states when the investor will get back the loan amount from the firm. If the
investor does not wish to hold the bond for the entire maturity period, he can sell
it. The selling price may be higher than the purchase price and therefore there
may be a possibility of a capital gain.

Sometimes a debt security does not have a coupon rate but it is sold at a discount,
which is at a price lower than its par value. The difference between the par value
and the purchase price at the maturity date is the interest to the investor. Hence,
the name fixed- income securities were given to reflect the mandatory payment
nature to the investor. In Malaysia, this security is also called a private debt
security. Examples of these securities include government and corporate bonds
and certificates of deposits.

Bonds provide a stable income to investors, hence, they are called fixed
income securities.

(b) Equity or Residual Claims

Investment in equity type securities represents an ownership share in a firm.

Unlike fixed-income securities, investors (equity holders) are not promised a fixed
amount of payment. When the company makes profits, they will receive dividends
if the firm makes a dividend declaration. They will also have a prorated claim over
the companyÊs real assets. If the company is successful, the value of the equity will
increase and vice versa. The performance of the equity investments is tied directly
to the success of the firm and its real assets. Investments in equity based securities
include investments in company shares. Investment in equity tends to be riskier
compared to debt securities.
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(c) Derivative Claims

Investment in derivative securities such as options and future contracts is the

latest form of investment.

Income is not directly linked to a specific firm but from the prices of other assets
such as bonds and shares. For example, when investing in call options or warrants
(usually attached to a mother share), the return from this investment is worthwhile
if the price of the mother share appreciates above the exercise price. The main
reason for the increased investment in derivatives is because firms want to hedge
or transfer their risk to other parties. Do not worry at this point if you are puzzled
about derivative claims. We will discuss the area in detail in topic 8.

(d) Hybrid Securities

Hybrid securities are securities that have the characteristics of an

equity and debt.

An example of hybrid securities is a loan stock. Loan stock is a debt instrument that
can be converted to share within a maturity period. Until the loan stock is
converted, the holder is entitled to the benefits that are accrued to a debt holder. The
investor will receive interest or coupon income. Once it has been converted, the
holder will then be an equity holder and will be entitled to all the rights and
privileges of a shareholder. An example of hybrid securities in the Bursa Malaysia
is Irredeemable Convertible Unsecured Loan Stock (ICULS).
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ACTIVITY 1.1

In the previous section, we discussed four types of financial investment.

Based on your understanding of the types of these financial investments,
list the advantages and disadvantages of each security. You can get additional
information about the securities from newspapers, the digital library and the
internet.

Types of Security Advantages Disadvantages

Debt claims
Residual claims
Derivative claims
Hybrid securities

1.4 FINANCIAL MARKETS

The Bursa Malaysia, the New York Stock Exchange and the Hong Kong Stock
Exchange are examples of financial markets. What is a financial market?

Financial markets provide venues for exchanging and creating value of

financial assets.

It provides the investor with the opportunity to trade financial assets in an

organised manner. In a financial market, both buyers and sellers meet to trade
in either debt or equity securities. There are at least 3 ways to classify the
financial market. They are:
Ć The type of financial claim, whether it is for a fixed dollar amount or by a
residual amount.
Ć Markets can also be classified according to where and when the securities are
acquired.
Ć Markets can be classified according to the maturity period of the security.
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ACTIVITY 1.2

Open your newspaper and look at the business section. What do these places
have in common - the Bursa Malaysia, the New York Stock Exchange and the
Hong Kong Stock Exchange?

Now, let us look at various types of markets available.

(a) Debt Market versus Equity Market

As explained in the financial investment section, a bond which is a debt
instrument is traded in the debt bond market. In Malaysia, trading of this
type of debt security is done in the private debt securities markets (PDS).
Equity type of security is normally traded in the stock or equity market. In
Malaysia, however, both these markets are located in the Bursa Malaysia.

Transactions in the Bursa Malaysia can be further categorised into the main
board and the second board. Shares of firms traded will qualify under a
particular board according to criteria set by the Security Commission.

Visit the Bursa Malaysia website at http://www.bursamalaysia.com

and get more information about the main board and second board.
Then, identify at least 3 companies listed under the main board and
second board. Why are these companies listed on the main board or
the second board?

Get more information on the criteria to determine which board shares

can be listed from the Security Commission website at
http://www.sc.com.my.

(b) Primary versus Secondary Markets

In order to obtain funds for operation purposes, firms can issue securities to
the public. However, issuance of the firmÊs shares can only be done after
all requirements and regulations of the Securities Commission and Bursa
Malaysia have been fulfilled. If it is the first time the firm is issuing the
security, the trade will occur in the primary market.
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A primary market is the market for new issues.

It is sometimes called the Initial Public Offering (IPOs) market. IPO is also a
means taken up by firms for the purpose of listing shares in the share
market. Firms will still have to go to the primary market if they intend to
issue additional securities. This additional issue is known as a seasoned
public offering.

Issues of shares that have been taken up in the IPOs market can
change hands among investors in the secondary market.

Investors can buy shares from the share market if they were not able to do
so from the primary market. In secondary market, shares are acquired from
other investors. Investors will have to go through a stock broking firm and
will be charged a transaction cost. Hence, subsequent purchase and sale of
shares is done in the secondary market. Bursa Malaysia provides the venue
for such trading activities.

(c) Money versus Capital Markets

Financial assets are also traded according to their maturity periods.

Short-term securities that mature for less than one year are normally
traded in the money market.

The short maturity period is a feature of the security that makes the money
market more liquid. Treasury bills, certificate of deposits and Bank Negara
notes are some examples of securities that are traded in the money market.
Institutional investors comprising mostly from financial institutions will
normally dominate this money market.

Assets that mature more than one year will be traded in the capital
markets.

In this market, both long-term debt and equity securities are traded. The
long-term nature of these securities makes this market less liquid. Investors
in this market are willing to wait longer for the profits of their investments.
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Investors in Cagamas Bonds that mature in 20 years will be receiving

interest payments from year 1 to 20. They have to wait 20 years before their
original principal investment is collected.

1.5 MARKET PLAYERS

Players in any financial market consist of three major participants. They are:

(a) Firms
Firms are the net borrowers who issue debt or issue equity securities if
they require funds. The funds generated from the issuance of these securities
will be invested in real assets in order to provide returns to investors.

(b) Household
Households are typically the providers of funds and are normally the net
savers. They purchase the securities issued by firms that need to raise fund.

(c) Governments
Governments are institutions that can be either borrowers or lenders
depending on the status of their tax revenue and expenditures.
Governments facing a budget deficit will normally borrow to finance their
activities. Alternatively, any surplus will be invested in various types of
securities.

1.6 TYPES OF INFORMATION

There is a wide variety of information to help investors make decisions.
Generally, we can categorise information into two forms.

(a) Analytical Information

Analytical information includes opinions on economic forecast, projections
on the effects on the share market and recommendations to buy or sell certain
share. Typically, a good broker will provide this service. You can sometimes
obtain some share market analysis from columnists in the newspapers.

(b) Descriptive Information

Descriptive information is that which gives historical and current data on
the market. Here you can obtain past information on the economy,
industry and companies. Newspapers carry a lot of these information.
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With the recent development, a lot of the above information can also be obtained
through the internet.

1.6.1 Broad Market Measures

Sometimes a quick indication of the condition of a market is needed. This is
particularly helpful when appropriate timing is required to enter the market.
Two measures of the market can be used that show the general market
condition.

An Index measures the current performance of a selected group of shares.

It is usually obtained by taking the current price of the selected shares and
comparing it with a base value. This base value would have already been set
earlier.

The Kuala Lumpur Composite Index (KLCI) is an example. It uses 100 shares from
the Bursa Malaysia. Apart from the KLCI, the Bursa Malaysia also produces
sectorial indices and the syariah index.

Another measure is an average.

Averages are obtained by taking the arithmetic average price of a selected

number of shares at a given point of time.

The most famous is the Dow Jones Industrial Average (DJIA).

1.6.2 Price Information

Let us look at some basic information that you can get from a newspaper. As
mentioned earlier, most of the information is descriptive in nature. Some analysis
is provided by columnists.

The Bursa Malaysia price data are reported based on sectors. Shares are listed
according to their sectors. This classification is based on the principal activity of a
company. However, this can be quite ambiguous since a company may have a lot
of different activities.
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A daily newspaper price report on each share will normally consist of the
company share code and its name. Three kinds of prices will be reported. They
are the highest and lowest prices for the year and the closing price. The closing
price is the last price traded the day before. The report will also include any price
changes from the day before yesterday. Lots traded is the number of lots that
changed hands between investors. One lot is equal to 200 units of shares. The
term Div Yield is the dividend yield. This measure is obtained by taking the
dividend divided by the price. It shows the share returns in terms of its
dividends. The Price Earnings (PE) ratio is the earnings divided by price. The
next figure beside the PE ratio is the market capitalisation figure. This is obtained
by taking the number of shares times the price. Topic 5 of this module will
discuss the usage of dividend yields and PE ratios.

In the loans and debenture section, you will see some information on outstanding
bonds and debentures. The majority of them are loan stocks. The report will show
the closing price as well as the years highest and lowest prices. A bond normally
has a par value of RM100. Therefore a closing price of RM104 means that the
bond is traded at a premium. A closing price below the par value is a discount
bond. The report also shows the date of issue and the maturity date. The rate
quoted in the report is the coupon rate. The yield is the return required by
investors from the bond. The coupon rate may not be the same as the yield. If the
closing price is higher than RM100, then the yield is lower than the coupon rate.
You will see this relationship in Topic 7 of this module.

The report also shows the date you can get your coupon payment.

In the unit trust section, you will see information like buy, sell, NAV, initial
charge and Annual fee.
Ć The price listed under column Buy is the price the unit trust will buy back
from the unit holders.
Ć Under the column Sell is the price you have to pay if you want to buy the unit
trust.

Notice that the buy price is lower than the sell price. NAV is the net asset value. It
is obtained by taking the market value of the trust less expense divided by the
number of units. Market value of the trust will represent the market value of
shares or bonds held by the trust.
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Test your understanding by attempting the questions below.

SELF-TEST 1

1. Differentiate between financial and physical assets.

2. List three examples of financial assets.

3. Explain what „debt instrument being a claim on the firmÊs assets‰

means.

4. Explain the returns that you can get from a share.

• Investment refers to current commitment of present resources, mainly money,

in the hope of gaining future benefits.
• There are four categories of financial investments, namely;
(a) Debt Claims
(b) Equity or Residual Claims
(c) Derivative Claims
(d) Hybrid Securities.
• The financial markets provide venues for exchanging and creating value of
financial assets and the players involved are firms, household and
governments.
• Investors require analytical information and descriptive information in
investment decision making.