ABMF2093 Principles of Investment

Tutorial 1: Introduction to Investment

(Answer)
1. i. What is investment?
Any vehicle into which funds can be placed with the expectation
that it will generate positive income and/or preserve or increase
value.

ii. Why do we invest?

We invest to improve our welfare, which for our purposes can

be defined as monetary wealth, both current and future.
Funds to be invested come from assets already owned,
borrowed money, and savings or foregone consumption. By
foregoing consumption today and investing the savings,
investors expect to enhance their future consumption
possibilities by increasing their wealth.
Investors also seek to manage their wealth effectively,
obtaining the most from it while protecting it from inflation
and others factors.

2. i. What are returns? Discuss.

Returns are the level of profit from investment i.e the reward for
investing.

The 2 Components of Return are:

i. Current Income/yield
- Measures the cash flow and relating it to purchase price
Example: Dividend, interest rate.

ABMF2093 Principles of Investment

ii. Increased in value/capital appreciation
-

Positive price change i.e the difference between selling

price and cost price.
Include unrealized gains ~ Paper gain or gains that are not
received because asset is not yet sold.

Total Return= Yield + capital appreciation

ii. What are risks? Discuss.

Is the uncertainty about the actual return that will be earned

on an investment different from the expectation.
Actual outcome differs from expected outcome

iii. What is the relationship between Risk and Return?

Risk and Return is inter-related with each other

Risk is the uncertainty of actual return differ from expected
return
Return is the reward from investment for taking the risk
Investors generally must decide their risk tolerance i.e. how
much risk they are willing to accept to be compensated
accordingly
Generally.
LOW RISK, LOW RETURN

HIGH RISK, HIGH RETURN

3. Historically, stocks on average have out performed other asset

classes such as bonds. Should all intelligent investors own stocks?

ABMF2093 Principles of Investment

Yes, but investor must be aware of the risk involved and to an extent
be able to mitigate that risk. Investors must decide their risk
tolerance how much risk they are willing to accept. If their risk
tolerance is low, they should invest in low risk investments such as
government bonds. If their risk tolerance is high, they should invest
in high risk investment such as stocks.

4. Rational investors always attempt to minimize their risk. Agree or

disagree, explain your reasoning.
Agree. Investors are risk-adverse, they are rational and will not
assume risk unless they are compensated.

5. Explain the three types of individual income.

a. Active income: It is made up of income earned on the job as well
as most other forms of non-investment income.
b. Portfolio income: It is the earnings generated from various types
of investments.
c. Passive income: It is a special category of income derived from
real estate.

6. Why are money markets the safest type of investment?

Because of the shorter time frame
Offer certain return that there will be no default in payment.
7. Is an initial public offering an example of a primary or a secondary
market transaction? Explain.
A primary market is the market in which corporations raise capital
by issuing new securities. An initial public offering is a stock issue in
which privately held firms go public. Therefore, an IPO would be an
example of a primary market transaction.

ABMF2093 Principles of Investment

8. Indicate whether the following instruments are examples of money
market or capital market transactions.

U.S. Treasury bills

Long-term corporate bonds
Common stocks
Preferred stocks

A money market transaction occurs in the financial market in which

funds are borrowed or loaned for short periods (less than one year).
A capital market transaction occurs in the financial market in which
stocks and intermediateor long-term debt (one year or longer)
are issued.

a. A U.S. Treasury bill is an example of a money market transaction.

b. Long-term corporate bonds are examples of capital market
transactions.
c. Common stocks are examples of capital market transactions.
d. Preferred stocks are examples of capital market transactions.

9. If T & L Corporation decided to issue additional common stock, and

Tony purchased 100 shares of this stock from an underwriter, would
this transaction be a primary market transaction or a secondary
market transaction? Would it make a difference if Tony purchased
previously outstanding T & L Corporations stock in the market?
If tony purchased newly issued T & L corporation stock, this would
constitute a primary market transaction, with an investment banker
in the transaction.
if tony purchased used stock, then the
transaction would be in the secondary market.

10. An investor buys a bond for Rm10,000. The bond pays RM300
interest every six month. After 18 months, the investor sell the bond
for RM9,500. Describe the type of income and /or loss the investor
had.
Answer:

ABMF2093 Principles of Investment

The investor had interest income of $900 (three payments of $300
each), and a capital loss of $500.