Business Analysts Handbook

Financial Business Analysis[]



The basic principle of investment is to put spare money to work. But it is not that easy. The easy way to double your money is to fold it in half and put it in your pocket.This humorous remark put forth the quandary of investment to earn securely, quickly and easily. An investment is to place your money to earn more money. Before taking a decision about the type of investment, one needs to determine accessibility of the investment. Needs and requirements are personal decisions affecting selection of the type of investment to be made. Long term investment will fetch high returns but money become untouchable for a long time as compared to short term investments. Some income has to be sacrificed to improve accessibility.

Contents 1. Determination of acceptable risk. 2. Types of available investments. 3. Diversification of investments. 4. High Yield Bonds. 5. Short term investments are less sensitive and provide diversification. 6. Conclusion. 7. Resources

1. Determination of acceptable risk Determination of acceptable risk is the factor to evaluate potential returns. The higher the level of risk, the higher the return will be. More secure investments generally offer less return but guarantee part or all of investments. Accordingly risk tolerance and income expectation need to be evaluated in order to arrive at best investment. Size of investment is another great factor to determine the acceptable risk. Large investments can be apportioned between long term and short term investments in order to reach equilibrium. Source of investment is an important factor to achieve required financial goals. Investment out of savings will increase the risk taking ability of the portfolio. If loans are used for investing, liability reduces entrepreneurial capabilities. Savings allow making more money with money. Above all before evaluating the real profitability of the investments inflation rates need to be considered. If interest rates are at 7% and the inflation rates are 5%, the earning is only 2% before taxes.

2. Type of available investments Generally investments available in the money market are Bank deposit (both saving and term deposits), Bonds, Treasury bills, Stocks (equities) and Investment Funds (mutual funds). Every type of investment has its own advantages and drawbacks in terms of yield, liquidity, security and diversification of investments. Saving accounts are highly secured and liquid. Interest rates are generally low for saving accounts. Term deposits are frozen for the fixed term but carry high interest rates than saving accounts. Bonds are quite secure with large liquidity and fixed return for determined period. Bonds are also available in multiple denominations. Treasury bills are very secure short term investment but carry no fixed interest rate but rather a face value. These are bought at a discount and sold again at its face value at the expiration date. The difference between the two makes up the return. Stock is broadly are two types- ordinary and preferred. They are easily accessible funds. The level of stock prices and their return vary and therefore do no guarantee revenue. Mutual funds allow investors to have access to a large range of diversified investments. Investor’s money is pooled with money of numerous other investors.

3. Diversification of investments Investor has to understand the nature of investment and its inherent risks before evaluating the investment with the objective of investment portfolio. Investment need not be based on tips and rumors. Diversification of investment is highly suggestible as the old saying goes not to put all eggs in one basket. The investment portfolio need to be reviewed periodically, say quarterly, every six months or once a year to ensure its objectivity. Further risky investments are not good for short term personal goals like purchasing a home, computer or trip. An investment in money market is not insured or guaranteed by any agency. A money market fund’s (say a mutual fund) yield and return will vary if diversification of investment is not done taking into consideration market risks. Investment remain exposed to numerous market risks, namely, call risk, credit risk, inflation risk, interest rate risk, risk of fixed income investing and many more.

4. High Yield Bonds The financial environment these days is of low interest rates and equity uncertainty. Naturally investors are seeking alternative sources of return. These days’ investors are increasing looking for high yield investments. The prime consideration when analyzing high yield investments is to ensure diversification. In this regard High Yield Bonds are distinct and separate investment assets. They are separate because of an expected return and hybrid in nature. High yield bonds have characteristics of both fixed income and equity (price appreciation wise).With low correlation of returns to both the bond and equity markets high yield bonds provide investors with unique nature of diversification. The trend in financial circuit is that adding high yield bonds into either a fixed income or equity portfolio is expected to improve the total portfolio’s risk and return characteristics over a long term horizon. High yield bonds offer investors one of the best risk adjusted returns. From long term perspective another investment opportunity in shape of Loan –Participation Funds is worth considering. These are also called Bank Loan Funds or Floating Rate Fund. These funds invest in loans that are made by banks to companies with low credit and present high risk of default... These funds are worth the risk unless economy is turning downward or if investment is required back shortly.

5. Short term investments are less sensitive and provide diversification. . Short term investments objectives represent another scenario. If invested in short to medium term bonds, they provide security in the form of instant diversification, professional management and quick liquidity. Short term investments are also less sensitive to interest rates changes because, shorter the investment maturity, the less likely is that interest rates will fluctuate. If invested in short term bonds, bond price rise when interest rates fall, and vice versa. But generally a bond fund is made up of many individual bonds, which help to reduce credit risk.

6. Conclusion For years financial experts have urged investors to spread their money across different types of assets classes such as stocks, bonds and others in order to reduce risk and enhance long term returns. Proper diversification is an important factor to achieving long term financial success. Investment is putting one’s money at risk in the hope of a good return on money invested.

7. Resources

Books: Baruch Fischhoff, Sarah Lichtenstein, “AcceptableRisk” Siegel, “Stocks for the Long Run. The definitive Guide to……..”