Page 7 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes 1.1 Concept of Investment

We invest in order to improve our future welfare. Funds to be invested come from assets
already owned, borrowed money, and savings or foregone consumption. By foregoing
consumption today and investing the savings, we expect to enhance our future consumption
possibilities. Anticipated future consumption may be by other family members, such as education
funds for children or by ourselves, possibly in retirement when we are less able to work and
produce for our daily needs. Regardless of why we invest, we should all seek to manage our
wealth effectively, obtaining the most from it. This includes protecting our assets from inflation,
taxes and other factors.
1.1.1 How Do We Invest?

If we are making investment decisions today that will directly affect our future wealth, it would
make sense that we utilize a plan to help guide our decisions. Surprisingly, the majority of
people do not have in place any type of formalized investment plan. Taking some time to put
together a financial plan can reap tremendous benefits. First, let’s define financial planning.
Financial planning is the process of meeting your life goals through the proper management of
your finances. Life goals can include buying a home, saving for your child’s education or planning
for retirement.

Financial planning provides direction and meaning to your financial decisions. It allows you to
understand how each financial decision you make affects other areas of your finances. For
example, buying a particular investment product might help you pay off your mortgage faster
or it might delay your retirement significantly. By viewing each financial decision as part of a
whole, you can consider its short and long-term effects on your life goals. You can also adapt
more easily to life changes and feel more secure that your goals are on track.

1.1.2 Nature of Investment Decisions

You have understood that an individual invests or postpones current consumption only in
response to a rate of return which must be suitably adjusted for inflation and risk. The basic
postulate, in fact, unfolds the nature of investment decisions. Let us explain as follows:
Cash has an opportunity cost and when you decide to invest it, you are deprived of this opportunity
to earn a return on that cash. Also, when the general price level rises the purchasing power of
cash reduces. This explains the reason why individuals require a ‘real rate of return’ on their
investments. Now, within the large body of investors, some buy government securities or
deposit their money in bank accounts that are adequately secured. In contrast, some others
prefer to buy, hold, and sell equity shares even when they know that they get exposed to the risk
of losing their money much more than those investing in government securities. You will find
that this latter group of investors is working towards the goal of getting larger returns than the
first group and, in the process, does not mind assuming greater risk. Investors, in general, want
to earn as large returns as possible subject, of course, to the level of risk that can possibly bear.
The risk factor gets fully manifested in the purchase and sale of financial assets, especially equity
shares. It is common knowledge that some investors lose even when the securities markets
boom. So there lies the risk.

You may understand risk, as the probability that the actual return on an investment will be
different from its expected return. Using this definition of risk, you may classify various
investments into risk categories.

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