Unit 6: Introduction to Investments

Lesson 6.1
Introduction to Investments
Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 4

Definition of Investment 4
Objectives for Investing 5
Associated Risks 6
Classifications of Investment 8
Different Investment Risks 10
Business Risk 11
Market Risk 11
Financial Risk 11
Liquidity Risk 12
Exchange Rate Risk 12
Country Risk 13
Investment Risk Management 13
Diversification 13
Investing Consistently 14
Investing for the Long Term 14

Keep in Mind 14

Try This 15

Practice Your Skills 16

Challenge Yourself 18

Photo Credits 19

Bibliography 19
Unit 6: Introduction to Investments

Lesson 6.1

Introduction to Investments

Introduction

Several years from now, most of you will probably be working adults: spending hours at the
office to earn enough to support your needs. Most people work for money, but have you
considered making your money work for you? Will you take a chance to invest your
hard-earned money? If so, how much are you willing to invest? Do you know which
investments are suitable for you? The answers to these questions depend on your financial
literacy.

Most experienced investors are aware of the risks that come along with investment.
However, the internet has enormous information that may deceive inexperienced investors.
Investments are always presented to potential clients as profitable and safe, but all
investments have risks. This lesson will introduce you to investments and their common
risks.

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Unit 6: Introduction to Investments

Learning Objectives DepEd Competencies

This lesson serves as prerequisite for the

In this lesson, you should be able to do the
following DepEd competencies:
following:
● Compare and contrast the different
● Define investment and risk. types of investments
(ABM_BF12-IVm-n-23).
● Analyze the risks associated with an
● Classify investment according to its
investment or business situation. type and features, and advantages and
disadvantages (ABM_BF12-IVm-n-24).
● Relate the concept of investment and
risk with other financial management
processes.

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Unit 6: Introduction to Investments

Quick Look

Risk Tolerance Assessment

Do you think you are a risk taker? Or do you tend to stay on the safe side? Risk tolerance is
one of the primary considerations when making investment decisions.

Search the internet for tests of “Risk Tolerance Assessment.” Several websites will let you try
their tests for free. Accomplish the test, get the results, and answer the following questions.

Questions to Ponder
1. What factors affected your decision in choosing between options? What does it say
about your risk tolerance?
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2. Based on the assessment, how does risk tolerance affect the type of investment a
person chooses?
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3. Aside from risk factors, what other variables will you consider when investing?
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Unit 6: Introduction to Investments

Learn the Basics

In the previous lessons, you have learned that investments are always associated with risks
and return. The risk-return tradeoff is a fundamental underlying principle in investment
decisions. In general, it states that the higher the risk, the higher the potential return of an
investment.

Return refers to the outcome gained from an investment. On the other hand, risk refers to
the variability of the results or the chances that the actual return will vary from what was
expected. Thus, investors tend to seek the maximization of returns while minimizing risk.

Essential Question

Why should risks be considered all the time when making investment
decisions?

Definition of Investment
An investment is an asset or item purchased that is expected to earn money or increase in
value. In finance, an investment is a monetary asset purchased to earn a return on
investment (ROI). The ROI from an investment can be in the form of income (interest or
dividends), capital gains (when the asset is sold for more than it was purchased for), or
appreciation (an increase in the value of the asset).

Figure 1. Depending on the type of investment, returns can come in different forms.

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Objectives for Investing
The purpose of investing varies from one person to another. Yet, it is essential to
comprehend the main objectives of investment. These objectives guide investors in deciding
the type of investment that is appropriate for them. People generally invest their money for
financial safety, income, and growth.

Figure 2. The common reasons for investing

1. Safety of Money
Some people invest to safekeep their money. However, no investment is risk-free. The
engagement with a specific type of investment depends on the investor's risk
tolerance.

If an individual's primary objective is safety and security, the investment must have
minimal risk. Investment with small returns is the safest investment.
Government-issued securities, money market instruments, and bank-guaranteed
securities are examples of these.

2. Source of Income
People work jobs to earn regular income. However, wages and salaries are generally
unvarying and typically used to cover daily costs. People who want to have other

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sources of income aside from their wages or salaries put their money into
revenue-generating investments. This way, their salaries cover their present needs
and their investments will be used for future needs. Dividend stocks, bonds, real
estate assets, and money market funds are examples of revenue-generating
investments.

3. Money Growth
Businesses are established with the expectation of earning profits. Similarly,
investment involves capital appreciation, a long-term goal that helps investing entities
guarantee their financial future. Real estate, mutual funds, commodities, and stock
are the most vital assets for long-term growth.

Check Your Progress

Relate the objectives of investing with the various forms of investment

returns. How can these factors help in investing decisions?
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Associated Risks
Many people think of investing as gambling. While gambling and investment have
commonalities, such as risk and expected return, many more factors are involved in
investing.

Investors are inevitably exposed to risks. There is no assurance that any investment will
generate a return as all investments involve some risk. It is possible to lose money on an
investment, and investors should be prepared for this. However, unlike gambling, the risks
can be computed and managed.

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Table. The Similarities and Differences of Investing and Gambling

Gambling Investing

1. You are expecting a return from the money you have invested.
Similarities
2. There is a risk that you will not receive any return

1. Its returns heavily rely on 1. Most investments are

chances. secured (i.e., bank deposits).
2. The risk will always be 2. Risks can be computed; thus,
Differences all-or-nothing. these can be managed.
3. Once the game is over, the 3. It takes time for your
chance of a higher return investment to grow and
comes to an end. appreciate.

To manage risks, investors put their money in various asset classes such as stocks, bonds,
real estate, and cash. This strategy of minimizing the risk of loss is called diversification.
The principle behind diversification is that an investor will less likely experience huge losses
when one asset declines in value.

Some investment strategies are more aggressive than others, while some are more
speculative. Considering an investment strategy before making investment decisions is
essential, as each has advantages and disadvantages.

Check Your Progress

What are the differences between investment and gambling?

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Classifications of Investment
Before an investor invests in different financial assets, it is important to understand
investments according to their classification.

Figure 3. Investments may be classified in various ways

1. Security or Property
Investments can be classified as either securities or property. Security represents
ownership or indebtedness of a business. Companies and governments can issue
securities; thus, investors have the right to financial claims over the organization's
assets. Common examples of securities issued are stocks for ownership of a business
and bonds for a company's indebtedness.

On the other hand, a property is a tangible investment. These properties can be

categorized into real property or tangible personal property.

2. Direct or Indirect
Direct and indirect investments present the manner of acquisition of the investment.
An investment is considered a direct investment when the investor acquires the
financial asset directly from the company. On the other hand, indirect investment is
acquired through the aid of a financial intermediary or person.

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3. Debt, Equity, and Derivative Securities
Investments can also be classified according to the source of financing. Debt
securities refer to financial obligations to investors for letting the organization
borrow funds from them. In exchange for these funds, debt securities are issued plus
interest. One of the most common debt instruments is a bond.

Equity securities represent ownership of a business. When a company issues equity

securities to an investor, the latter has the legal right to claim interests in the
business. The common equity securities are stocks. Derivatives derive their value
from another underlying asset. Examples of derivative securities are futures and
options.

4. Low- and High-Risk Investments

The most common way of classifying investments is through risk-level identification.
Low-risk investments are more secured and stable in terms of their yields. However,
this type of investment gives low returns as well. One of the most common low-risk
investments is a bank deposit. People usually deposit their money in banks that yield
low-interest incomes. Still, they are sure the bank will return their money safely
because they are secured.

On the other hand, high-risk investments may not regenerate income nor be
returned to investors. An example of a high-risk investment is a stock investment. Due
to the price volatility of stocks, there is a high chance that their funds may increase or
decrease in value.

Figure 4. The risk and return tradeoff

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5. Short-term and Long-term Investments
When investments are classified according to their maturity, they could be either
short-term or long-term. Short-term investments mature within twelve months or a
year. An example of this is a time deposit. Most time deposits mature between 30
days, 60 days, 90 days, 180 days, or 360 days. In contrast, long-term investments
mature longer than a year or those investments that lack the specificity of the
maturity date.

6. Domestic and Foreign Investments

Investments can also be classified into domestic or foreign investments. Domestic
investments are those securities that home-grown companies issue. If, for instance,
the stocks you have invested in are issued by a local company, it is considered a
domestic investment. On the one hand, foreign investments are those securities
that foreign-based companies issue.

Different Investment Risks

Investments are the means to achieve one’s financial goals. While individuals want risk-free
investments that would yield higher returns, this notion is considered “too good to be true.”
And so, as the risks increase, investors must decide which investment is suitable for their
financial needs and goals.

Investors have different levels of risk tolerance. Some investors are willing to take on more
risk to potentially earn a higher return, while others prefer to invest in less risky investments
to minimize the chances of loss. However, there are also different types of risks. Certain
types of investments are more affected by a particular risk than others. Figure 5 shows the
most common types of risk that affect investments.

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Figure 5. Types of risks that affect investments

Business Risk
Business risk refers to uncertainty surrounding an investment's revenues and ability to
deliver the expected returns (interest, principal, and dividends). For example, investors may
receive no return if the firm's earnings are insufficient to pay obligations. On the other hand,
creditors are likely to receive some (but not all) of the money owed to them due to the
special treatment that debt receives under the law.

Market Risk
Market risk refers to the possibility that investment returns would suffer from events
influencing the entire market rather than just one firm or investment. Political, economic,
and social upheavals and changes in investor tastes and preferences are examples of market
risk. Market risk encompasses a variety of concerns such as purchasing power, interest rate,
and tax risk.

Financial Risk
Financial risk is the more significant uncertainty arising when a company borrows money.
The more debt a company uses relative to its assets and profits, the bigger its financial risk.
Businesses in all industries are exposed to the ups and downs that are called business risk,

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but companies that employ more debt are at an even higher risk.

When a company borrows money, it agrees to make future interest and principal payments.
This commitment is not dependent on its profits but is set by a contract between the
company and its lender. When business conditions are excellent, and profits are good,
shareholders benefit from the earnings from the additional fund acquired from debt.

However, when business circumstances are dire, firms still need to settle their loans'
principal and interest amount. In that situation, debt multiplies the losses that shareholders
must bear; therefore, a company that employs debt will suffer more losses in difficult times
than a company that does not. In other words, debt multiplies a firm's business risk if it has
more considerable earnings in good times and steeper losses in poor times (relative to a
firm that borrows no money).

Liquidity Risk
Liquidity risk refers to being unable to sell or liquidate an investment fast enough without
lowering its price. A liquid investment is one that investors can sell rapidly without lowering
its price. For instance, security purchased for ₱100,000 would not be considered highly liquid
if one could only sell it promptly for, say, ₱95,000. The liquidity of an investment is an
essential factor to consider in investing decisions. Thin-market investments are generally less
liquid than those traded on broad markets, with limited transaction volume.

Exchange Rate Risk

Exchange rate risk refers to the possibility that an unexpected change in the exchange rate
between the foreign and the local currency in which a project's cash flows are denominated
could lower the cash flow's market value. If the local currency depreciates against the dollar,
the dollar worth of future cash inflows can be substantially affected.

Specific cash flows can be hedged in the short-term using financial products like currency
futures and options. The most significant way to reduce long-term exchange rate risk is to
finance the project entirely or partially in local currency.

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Unit 6: Introduction to Investments
Country Risk
Country risk is the possibility that a country will experience political or economic instability
that could adversely affect the performance of an investment. Country risk can be divided
into four categories:

1. Political risk: the risk that a country will experience changes in its government or
policies that could negatively impact investments
2. Economic risk: the risk that a country will experience economic downturns or
instability that could adversely affect investments
3. Social risk: the risk that a country will experience social unrest or upheaval that
could adversely affect investments
4. Natural disaster risk: the risk that a country will experience natural disasters, such
as earthquakes, hurricanes, or floods, could adversely affect investments

Check Your Progress

How can the type of risk influence the investment decision of an individual?
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Investment Risk Management

The process of identifying, measuring, and managing investment risks is referred to as
investment risk management. It aims to protect and grow assets by diversifying
investments, investing consistently, and investing for the long term.

Diversification
One of the most important aspects of investment risk management is diversification. By
diversifying investments into various asset classes, such as stocks, bonds, and cash, an
individual can reduce the risks of investing. Diversification helps protect the portfolio from
the risks associated with any particular investment.

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Investing Consistently
Investing consistently means investing a fixed amount of money each month, regardless of
the stock market conditions. This discipline helps to smooth out the ups and downs of the
stock market and allows to take advantage of long-term growth.

Investing for the Long Term

Investing for the long-term means investing with a time horizon of at least five years. This
time frame gives the markets time to recover from short-term volatility and provides the
potential for greater returns.

Check Your Progress

How can the type of risk influence the investment decision of an individual?
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Keep in Mind

● An investment is an asset or item purchased that is expected to earn money or

increase value. Investors buy it, expecting a return, which may come from income,
capital gains, or value appreciation. However, investments have associated risks.

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● The risk-return tradeoff is an underlying principle in investing decisions. All
investments have associated risks. However, unlike gambling, the risks in financial
assets can be calculated and managed.
● There are various ways to classify an investment. An investment can be:
○ security or a property
○ direct or indirect
○ debt, equity, or derivative
○ low-risk or high-risk
○ short-term or long-term
○ domestic or foreign
● Investments are exposed to different kinds of risks such as business risk, market risk,
financial risk, liquidity risk, exchange rate risk, and country risk. However, these can
be managed by diversifying, investing consistently, and investing long-term.

Try This

A. Identification. Write the correct answer in the provided space before each number.

___________________ 1. It is the type of investment risk caused by the inability of a

company to pay its debts or meet its financial obligations.

___________________ 2. It is the type of risk associated with ups and downs due to an
unsuccessful business model.

___________________ 3. It is the type of risk associated with an asset that is difficult to

sell without lowering its price.

___________________ 4. It is a type of country risk caused by changes in government

leadership and instability.

___________________ 5. It is the risk of a security's value going down because of

factors in the overall market conditions.

___________________ 6. It refers to the strategy of investing in various asset classes.

___________________ 7. It is the chance that changes in exchange rates will affect the

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value of an investment.

___________________ 8. It is the risk of natural occurrences affecting the value of

investments.

___________________ 9. This risk is associated with inflation, recession, and market

volatility.

___________________ 10. It is the likelihood that a country will experience political or

economic instability that could adversely affect the
performance of investments in that country.

Practice Your Skills

Assessing Risks
Read and analyze each item. Answer the questions in 2 to 3 sentences.

1. Maria bought an antique coin. She intended to hold it as an investment, expecting

that its value would rise and she could sell it for a higher price in the future. A few
years later, Maria urgently needed some money. She found an honorable antique
coin collector who told her that the coin would be difficult to sell at its full value due
to current market conditions and consumer preferences. Since Maria needed the
cash immediately, she offered to sell it at a much lower price than the coin's
supposed value. What risk/s did Maria fail to consider when she purchased the coin a
few years back?
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2. Mark offered Jose his idea for a printing business. The main customers are students
from a nearby school. It would only require a laptop, printer, and a supply of papers.
Marke needed ₱10,000 as start-up capital. He asked Jose for a loan and pledged to
pay back ₱10,000 and give Jose 25% of the profit for the first three months of the
business. In the first month, Mark earned some money. However, the school
suspended face-to-face classes, and he had to close the business. He could not
return the money he borrowed from Jose. Thus, Jose lost ₱10,000. What risk/s did
Jose experience? Explain your answer.
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3. Company ABC wants to invest in a particular country. Preliminary negotiations were

done, and the institutions sent the proposals. Suddenly, allegations of corruption
against the current government surfaced. The people of the country were highly
dissatisfied with their current leader. Analysts predict that a prolonged period of
power struggle will happen between the government and the opposition. What kind
of risk/s does Company ABC suddenly face? Explain your answer.
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Unit 6: Introduction to Investments
4. Danny was recently promoted to a higher position in his company. His salary
increased, and he now has extra funds amounting to ₱20,000 monthly. He wants to
use this money to start investing. Since he worked hard for his money, he wants to
ensure that there will be no loss and the investment is liquid. Describe Danny's
investment objectives and classify the type of investment suitable for his risk
tolerance.
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5. There are many benefits to diversifying your investment portfolio. Investing in

various assets can minimize your risk and maximize your potential for returns. Is
diversification suitable for all kinds of investors?
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Challenge Yourself

Answer the following questions:

1. It is essential for companies to carefully consider the financial risk to protect their
financial health and shareholders' investment. Recall the concept of insurance. How
can companies use it to manage financial risk?
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Unit 6: Introduction to Investments
2. Banks must maintain a certain level of liquidity to meet their obligations to
depositors. Recall which assets are essential in managing a bank's liquidity risk.
Explain how banks can use these assets.
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3. There is a chance that something could go wrong in your business. It can come from
financial, operational, legal, and reputational risks. How can you prevent this from
happening?
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Photo Credit

Coach wallet with TD and BMO credit cards by PiggyBank is licensed under Unsplash
License via Unsplash.

Bibliography

Gitman, Lawrence, and Chad Zutter. 2012. Principles of Managerial Finance 13th
Edition. Prentice Hall.

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Unit 6: Introduction to Investments
http://www.mim.ac.mw/books/Principles-of-Managerial-Finance-13th-Edition
_Full.pdf.9Ukgy8w1RYp7U1dls6CxRLDn1i8aezIq.

McLaney, Eddie. 2009. Business Finance Theory and Practice 8th Edition. Financial
Times Prentice Hall. https://dut.edu.ua/uploads/l_1872_56653010.pdf.

Melicher, Ronald, and Edgar Norton. 2017. Introduction to Finance 16th Edition. John
Wiley & Sons, Inc.
https://askmm.net/wp-content/uploads/2021/04/Introduction-to-Finance-by-
Ronald-W.-Melicher-Edgar-A.-Norton.pdf.

Smart, Scott, Lawrence Gitman, and Michael Joehnk. 2016. Fundamentals of Investing
13th Edition. Pearson Education Limited.
https://www.scribd.com/document/527749687/Gitman-Michael-Scott-Funda
mentals-of-Investing-Global-Edition-13e.

Thakur, Madhuri. 2019. “Investment Risk (Definition, Types) | What Is Investment

Risk?” WallStreetMojo. November 19, 2019.
https://www.wallstreetmojo.com/investment-risk/.

“What Is Investment: Meaning, Categories & Objectives of Investment.” n.d.

Www.maxlifeinsurance.com.
https://www.maxlifeinsurance.com/blog/investments/what-is-investment.

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