Choice of Investment
There are five major factors to be considered when choosing an
investment.
(a) Security: The most important is the security of the capital invested.
Investment should at least maintain their capital values.
(b) Liquidity: Where the investment are made with short term funds,
they should be capable of being converted back into cash at short
notice.
(c) Return: The funds are invested to make money. The highest return compatible with safety should be sought.
(d) Spreading risk: An investor who puts all his funds into one type of security risks everything on the future of that security. If it performs badly, his entire investment will be a loss. A better and more secure policy is to spread investment over several types of security so that a possible loss with one may be offset by gains in others. A planned spread of investment is known as portfolio.
(e) Growth prospects: The most profitable investments are likely to be in the securities of companies with growth prospects.
Investment of Surplus Funds
Permanent investment of surplus funds are essential for:
(a) Expansion of business;
(b) Obtaining control of allied activities;
(c) Buying over competitors;
(d) Replacement of assets.
Cash budgets reveal the quantity of funds available to the company for short term investment. Opportunities in this direction should certainly betaken.
Surplus cash will therefore call for an investment decision. This should
be based on the following facts:
(a) The amount available.
(b) The period for which the cash is available.
(c) Whether there is any possibility that the cash may be required prematurely to make unexpected payments.
The funds should be placed with credit-worthy borrowers. The aim
should be to secure the maximum interest possible consistent with a satisfactory level of risk and the required degree of liquidity or negotiability.
The outlets for the disposal of these surplus funds are as follows:
(a) Treasury Bills: These are designed to meet the short term financial needs of the government which issues them. They are sold mainly to the discount houses and banks who will receive suitable rate of
interest. The banks can acquire the bills for companies wishing to invest in this way. The bills are issued monthly with a normal maturity period of 91 days. Their interest rate is very low but they are liquid and can easily be sold.
(b) Tax Reserve Certificates: This has been dealt with during the treatment of sources of funds. The total amount held by companies fall in the first or last quarter of each year as the certificates are
surrendered in payment of the tax bill.
(c) Loans to or bonds of Local Authorities: These can be purchased with a period to maturity of anything from two days to five years. The company would buy a bond with a life span correlating as closely as possible to that of its surplus funds.
(d) Deposits with Commercial Banks: This is the commonest form of short term investment. Whereas deposits on current account earn no interest, money placed on deposit account does earn interest.
This form of investment is easy to undertake; it is extremely liquid (only a short period of notice is required before the withdrawal of the funds) and any amount can be deposited.
(e) Deposits with other areas of the Banking Sector: This includes deposits with acceptance houses, discount market, oversea and merchant banks. The merchant banks provide the normal banking services. Money can be placed on call in a current account or in a deposit account where 7 days notice is required before a with-drawal. Sometimes a minimum amount need be deposited.
(f) Deposits with Financial Houses: The arrangements and opportu-nities offered here are similar to those available in other areas of the banking community.
(g) Investment Trust Company: The company invests with the object
of gaining maximum long term growth. The income derived from these investments are utilised in several ways thus:
(I) Payment of interest charges on investment obtained from the public or companies.
(II) Payment of running expenses.
(III) Payment of dividends to shareholders.
(iv) Retained in the business.
(h) Speculative purchase of raw materials: The speculative purchase of raw materials may be necessitated by:
(I) Increase in price caused by the effect of devaluation or inflation.
(II) Purchase of raw materials or components made prior to increase in excise duty or introduction of tax.
(III)Where raw materials or components are regarded as limiting factor of production.
The following factors are however taken into consideration in accepting bulk purchase.
(I) Losses to be incurred due to obsolete stock.
(II) Savings of incidental costs in production and production
time during time of purchase.
(III) Elements of reduced cost in ordering.
(iv) Savings of premium payable on stock insurance as increased stock involves decrease in premium in that proportion.
Investment Trust
An Investment Trust Company is a quoted company with usually the same capital structure as any other kind of limited liability company. Its only objective is to invest its resources profitably and for this purpose it is usually managed full time by skilled and professional investment
experts. Whilst the price of Investment Trust shares will reflect the usual
forces in the market of supply and demand for the shares, it will also
relate in some way to the success or failure of the management of the
company to invest its money successfully. A feature of the Investment Trusts is that they tend to be what is often referred to as "geared". This means that the investment trust company borrows money in addition to its normal resources either from a bank or through a fixed interest debenture or convertible issue, and invest this money, so that if the value of those investments rises, the net asset value per ordinary share of the Investment Trust will rise considerably more than if the company was not geared.
Investment Trust shares are quoted in the Stock market in exactly the same way as any other kind of share and they can therefore be readily bought and sold by investors. They operate in exactly the same way as any other company and are governed by the usual requirements of
company law.