Very Short Question Answer

1. List out major characteristics of an investment.

The most common characteristics of investment are as follows:

  • Investment is undertaken with the expectation of earning a rate of return. Investment is the allocation of current saving with the expectation of more wealth for consumption in the future.
  • Every investment involves risk along with the return it generates. The risk return relationship of investment is always positive. Higher the level of risk associated, higher will be the investment returns.
2. Is saving an investment? Describe briefly.

A saving in isolation necessarily does not produce any returns. Therefore, saving is not investment. When saving is used to generate an expected rate of return, it transforms to the investment. For example, if we save money in home locker, it does not produce any returns, and hence it is not an investment. In contrast if we deposit the saving into an interest paying bank account, it is called an investment.

3. State the common characteristics of investment.

Investment is the commitment of funds at present with the expectation of generating more funds in the future. Investment can be in the form of real investment and financial investment. Real investment consists of the investment in productive assets like real-estate, plant and equipment, inventory and so on. Financial investment represents the claim on incomes and other assets such as investment in common stocks, bonds, Treasury bills and so on. The most common feature of investment is that it is undertaken with the expectation of earning a rate of return. Similarly, every investment involves risk along with the return it generates. The risk-return relationship of investment is always positive. Higher the level of risk associated, higher will be the investment returns.

4. How do you differentiate individual investors from institutional investors?

Individual investors are the individuals or persons who manage their own funds to achieve personal investment goal. The personal goal of individual investors may be to earn return on their surplus funds, secure retirement income and provide security for their family members. On the other hand institutional investors are the institutions that manage portfolio of investment using other’s money. For example, mutual funds, pension funds, insurance companies are institutional investors. Institutional investors basically create a pool of funds raised from individuals and invest into a large sized portfolio of investment.

5. Compare and contrast between Treasury bills and certificate of deposits.

 Both Treasury bills and certificate of deposits are short-term investment vehicles having less than one year of maturity. These investments are highly liquid that can be converted into cash without eroding their values. Treasury bills are short-term debt obligations issued by government. They are risk-free investment alternatives available to investors. They are generally sold at discount from their face value and investors receive back the face value at maturity. The difference between purchase price and the face value represents a rate of return to the investors. On the other hand, certificate of deposits are short-term negotiable deposit instruments issued by commercial banks. They are also liquid investment instruments available to investors. However, in terms of risk, they are placed above Treasury bills because the issuers of CDs are likely to default but not the government. For this reason, the yields on CDs are also slightly higher than the yield on T-bills.

6. Write short notes on Investment environment in Nepal.

Investment environment consists of securities, securities markets and securities regulations. Securities include financial assets such as common stocks, bonds, preferred stocks, and other investment alternatives such as mutual funds, pension funds, insurance policies and so on. In Nepal, common stocks are the most popular securities. Few companies have issued preferred stocks and bonds and the market for mutual funds, pension funds and insurance policies are also growing in Nepal. These securities are traded in securities market. Securities markets are primary and secondary markets. Both of these markets exist in Nepal. In primary markets companies raise new capital by issuing securities, while in secondary market, such as Nepal Stock Exchange, securities are traded among investors themselves. Security market transactions are conducted under the regulations of regulatory body like Securities Board of Nepal. Some of the regulations include Securities Act, 2007, Securities Board Regulation, 2007, Securities Businessperson Regulation 2007, Mutual Fund Regulation 2007, etc.

Short Question Answer

1. Discuss the several investment vehicles available to an investor. Which of these are common in Nepal?

There is very limited range of investment alternatives available in Nepal. Some of the important alternatives are as follows:

  • Equity securities: Among equity securities, common stocks are the most popular investment alternatives. The market for preferred stock is very thin in Nepal. Only a few preferred stock issues have been outstanding.
  • Debt securities: Among debt securities, short-term government deb obligations like Treasury bills and long-term government debt obligations like National Savings Bonds, Development Bonds, and Citizen Savings Bonds issued by Nepal Rastra Bank are popular securities in Nepal. The market for corporate debt securities like debenture and corporate bonds is yet to grow in sizeable amount.
  • Real assets: Real assets like gold and silver are also popular to some extent i Nepal. In recent period, real estate investment has been emerged as the in popular value generating investment alternative. However, it is yet to regularize.
  • Mutual funds: In recent period, Nepal has opened the scope of mutual fund operation through enactment of Mutual Fund Regulation, 2010. As a good number of mutual funds such as NCM Mutual Fund, Citizen Unit result a Scheme, Nabil Equity Fund have come into existence among others.
  • Derivative securities: Trading on derivative securities like commodity futures are also emerging due to the establishment of commodity or derivative market in private sector. However, it is yet to regularize.

Common Investment Alternatives Available in Nepal

There is very limited range of investment alternatives available in Nepal. Some of the important alternatives are as follows:

  • Equity securities: Among equity securities common stocks are the most popular investment alternatives. The market for preferred stock is very thin in Nepal. Only a few preferred stock issues have been outstanding.
  • Debt securities: Among debt securities, short-term government debt obligations like Treasury bills and long-term government debt obligations like National savings bonds, development bonds, and citizen savings bonds issued by Nepal Rastra Bank are popular securities in Nepal. The market for corporate debt securities like debenture and corporate bonds is yet to grow in sizeable amount.
  • Real assets: Real assets like gold and silver are also popular to some extent in Nepal. In recent period, real estate investment has been emerged as the popular value generating investment alternative. However, it is yet to regularize.
  • Mutual funds: In recent period, Nepal has opened the scope of mutual fund operation through enactment of Mutual Fund Regulation, 2010. As a result a good number of mutual funds such as NCM Mutual Fund, Citizen Unit Scheme, Nabil Equity Fund have come into existence among others.
  • Derivative securities: Trading on derivative securities like commodity futures are also emerging due to the establishment of commodity or derivative market in private sector. However, it is yet to regularize.
2. Discuss the present situation of investment environment in Nepal.

Investment environment consists of a set of components making up the investment activities. These components include securities, securities markets and securities regulations. The investment environment in Nepal is also composed of these components. They are described below.

  • Securities: Securities represent as the evidence of property right or claim on income and asset of an entity. They are financial assets such as common stocks, bonds, preferred stocks. They also include bank deposit accounts, insurance policies, investment in mutual funds and pension funds etc. Among several securities, the shares of common stock are the most common and popular types of securities in Nepal. Shares of common stocks in Nepal were first issued by Biratnagar Jute Mills and Nepal Bank Limited in 1937. Besides common stocks, government securities like treasury bills and bonds are other popular types of securities in Nepal. The first issue of government bond in Nepal was taken place in 1964. Other types of securities such as corporate bonds, preferred stocks are less common in practices. Only a few preferred stocks and corporate bonds are in the market; and municipal securities are yet to come. In recent time mutual funds units are emerging as the popular securities in Nepal. Among the short-term securities, Treasury bills issued by Nepal government are the most popular one in Nepal. Thus, there are limited choices of securities available in Nepal and the investors are bound to select among these limited alternatives for investment.
  • Securities Markets: Securities market refers to the market for trading securities. There are two types of securities markets: primary market and secondary market. Primary market is the market for selling securities by issuer to raise new capital and secondary market is the market for trading securities among the investors. The issuer of securities does not take part in secondary market transactions. In Nepal, both of these types of securities markets exist. The first transaction of primary market was taken place in 1937 when Biratnagar Jute Mills and Nepal Bank Limited issued shares of common stock for the public. The official forum for secondary market trading started with the establishment of Securities Marketing Center only in 1976. Later on Nepal Stock Exchange (NEPSE) Limited replaced this market in 1993 and formal secondary market trading in NEPSE started in 1994. In recent years, the primary market issues of securities have been more common among Nepalese banks and financial institutions due to the mandatory need of raising paid up capital. Until the recent period, secondary market transactions in NEPSE incorporate the trading of more than 240 listed securities. Secondary market trading in NEPSE initially began with open-out-cry system of trading, and it has been semi automated in recent years. It is yet to be fully automated. The size of the market in terms of number of traders and volume of trading is still small as compared to that of the developed markets, but it is growing gradually. The trading in NEPSE is being facilitated by 50 brokers. NEPSE trading is largely dominated by shares of common stock and the markets for preferred stocks and bonds are very thin. Mostly, the individual investors participate in NEPSE trading and the participation of institutional investor is very thin. In recent period some developments have taken place in secondary market transactions which include the over-the-counter (OTC) market operation by Nepal Stock Exchange, establishment of Securities Central Depository Services Company, and Institutional Credit Rating Agency (ICRA)
  • Securities Markets Regulation: Securities market regulation is comprised of regulatory body and regulatory provisions to systematize the securities transactions. Securities Board of Nepal (SEBON) is the apex regulator of securities market in Nepal. It was established under Securities Act of 1984. The Securities Act of 1984 was later replaced by Securities Act, 2007. Besides, a number of other regulations are in place to regulate the securities market in Nepal. They include Securities Board Regulation, 2007; Securities Businessperson Regulation, 2007; Securities Registration and Issues Regulation, 2008; Mutual Fund Regulation, 2010; Securities’ Central Depositaty Services Regulation, 2010, Credit Rating Regulation, 2011; and many other byelaws, guidelines and circulars made by SEBON. The establishment of SEBON has facilitated to make securities transaction transparent and systematic to a greater extent despite of some complains on the effective implementation of the legal provisions and supervision by the regulator.
3. What factors might an individual investor take into account in choosing among investment alternatives?

 An individual investor should consider several important factors in choosing among investment alternatives. They are described below.

  • Investment goal: Every investment should be guided by the investment goal. Therefore, the investor should consider her/his investment goal at the outset The investment goals may be appreciation in wealth, safety, liquidity combination of these goals. Generally, all investments are guided by the goal of wealth appreciation. Some of the goals are also dictated by the safety need and liquidity. The investment goal of investors always guides the selection of investment alternatives. Therefore, investor should establish her/his investment goal before making investment decision.
  • Risk and rate of return: Risk and rate of return are two closely associated factors in making investment decision. Every investment is undertaken to generate a positive rate of return. However, the rate of return expected from an investment must be consistent to the level of risk involved in investment. In other words, the rate of return expected from an investment must be sufficient to compensate against the level of risk involved in investing. Risk-return combination of investment alternatives must be consistent to the investment goal. For example, if the goal is to maximize wealth, the investor should select the risky alternatives because there is always a positive trade-off between risk and rate of return.
  • Tax consideration: Many investments are also dictated by the tax consideration. Taxes affect the rate of return from an investment. Some investments such as life insurance policies are tax exempted. Similarly capital gain returns are taxed at lower rate than the ordinary gains such as interest and dividend income. If the investor is in higher marginal tax bracket s/he may choose tax-exempted investment alternatives or the alternatives yielding higher capital gain. Similarly, the investors with lower marginal tax bracket may choose the higher yielding taxable alternatives.
  • Investment horizon: While selecting among the investment alternatives, the investor should also pay attention towards her/his investment horizon. If investors desire a consistent rate return over a longer period of time, s/he may choose long-term investment vehicles such as bonds. Similarly, if the investment horizon is short, the investors may go for short-term liquid investment vehicles such as Treasury bills.
  • Investment strategy: The investor should consider her/his investment strategy consistent to the investment goal before selecting investment alternatives. In considering the investment strategy, the investor should address the issues like investment selection, investment timing, and diversification. Investment selection is concerned with identifying appropriate investment categories and selecting appropriate securities in each category. Investment timing is concerned with configuring the right timing for buying and selling the securities. Generally investor should buy any investment alternative before its price will rise and sell before its price will decline. The issue of diversification is also important to minimize the investment risk. Generally,. a portfolio of investment must be well diversified by including different classes and categories of securities to minimize the investment risk.
4. Explain the factors affecting the choice of investment alternatives.

An individual investor should consider several important factors in choosing among investment alternatives. They are described below.

  • Investment goal: Every investment should be guided by the investment goal. Therefore, the investor should consider her/his investment goal at the outset The investment goals may be appreciation in wealth, safety, liquidity combination of these goals. Generally, all investments are guided by the goal of wealth appreciation. Some of the goals are also dictated by the safety need and liquidity. The investment goal of investors always guides the selection of investment alternatives. Therefore, investor should establish her/his investment goal before making investment decision.
  • Risk and rate of return: Risk and rate of return are two closely associated factors in making investment decision. Every investment is undertaken to generate a positive rate of return. However, the rate of return expected from an investment must be consistent to the level of risk involved in investment. In other words, the rate of return expected from an investment must be sufficient to compensate against the level of risk involved in investing. Risk-return combination of investment alternatives must be consistent to the investment goal. For example, if the goal is to maximize wealth, the investor should select the risky alternatives because there is always a positive trade-off between risk and rate of return.
  • Tax consideration: Many investments are also dictated by the tax consideration. Taxes affect the rate of return from an investment. Some investments such as life insurance policies are tax exempted. Similarly capital gain returns are taxed at lower rate than the ordinary gains such as interest and dividend income. If the investor is in higher marginal tax bracket s/he may choose tax-exempted investment alternatives or the alternatives yielding higher capital gain. Similarly, the investors with lower marginal tax bracket may choose the higher yielding taxable alternatives.
  • Investment horizon: While selecting among the investment alternatives, the investor should also pay attention towards her/his investment horizon. If investors desire a consistent rate return over a longer period of time, s/he may choose long-term investment vehicles such as bonds. Similarly, if the investment horizon is short, the investors may go for short-term liquid investment vehicles such as Treasury bills.
  • Investment strategy: The investor should consider her/his investment strategy consistent to the investment goal before selecting investment alternatives. In considering the investment strategy, the investor should address the issues like investment selection, investment timing, and diversification. Investment selection is concerned with identifying appropriate investment categories and selecting appropriate securities in each category. Investment timing is concerned with configuring the right timing for buying and selling the securities. Generally investor should buy any investment alternative before its price will rise and sell before its price will decline. The issue of diversification is also important to minimize the investment risk. Generally,. a portfolio of investment must be well diversified by including different classes and categories of securities to minimize the investment risk.
5. Explain the investment environment in Nepal.

Investment environment consists of a set of components making up the investment activities. These components include securities, securities markets and securities regulations. The investment environment in Nepal is also composed of these components. They are described below.

  • Securities: Securities represent as the evidence of property right or claim on income and asset of an entity. They are financial assets such as common stocks, bonds, preferred stocks. They also include bank deposit accounts, insurance policies, investment in mutual funds and pension funds etc. Among several securities, the shares of common stock are the most common and popular types of securities in Nepal. Shares of common stocks in Nepal were first issued by Biratnagar Jute Mills and Nepal Bank Limited in 1937. Besides common stocks, government securities like treasury bills and bonds are other popular types of securities in Nepal. The first issue of government bond in Nepal was taken place in 1964. Other types of securities such as corporate bonds, preferred stocks are less common in practices. Only a few preferred stocks and corporate bonds are in the market; and municipal securities are yet to come. In recent time mutual funds units are emerging as the popular securities in Nepal. Among the short-term securities, Treasury bills issued by Nepal government are the most popular one in Nepal. Thus, there are limited choices of securities available in Nepal and the investors are bound to select among these limited alternatives for investment.
  • Securities Markets: Securities market refers to the market for trading securities. There are two types of securities markets: primary market and secondary market. Primary market is the market for selling securities by issuer to raise new capital and secondary market is the market for trading securities among the investors. The issuer of securities does not take part in secondary market transactions. In Nepal, both of these types of securities markets exist. The first transaction of primary market was taken place in 1937 when Biratnagar Jute Mills and Nepal Bank Limited issued shares of common stock for the public. The official forum for secondary market trading started with the establishment of Securities Marketing Center only in 1976. Later on Nepal Stock Exchange (NEPSE) Limited replaced this market in 1993 and formal secondary market trading in NEPSE started in 1994. In recent years, the primary market issues of securities have been more common among Nepalese banks and financial institutions due to the mandatory need of raising paid up capital. Until the recent period, secondary market transactions in NEPSE incorporate the trading of more than 240 listed securities. Secondary market trading in NEPSE initially began with open-out-cry system of trading, and it has been semi automated in recent years. It is yet to be fully automated. The size of the market in terms of number of traders and volume of trading is still small as compared to that of the developed markets, but it is growing gradually. The trading in NEPSE is being facilitated by 50 brokers. NEPSE trading is largely dominated by shares of common stock and the markets for preferred stocks and bonds are very thin. Mostly, the individual investors participate in NEPSE trading and the participation of institutional investor is very thin. In recent period some developments have taken place in secondary market transactions which include the over-the-counter (OTC) market operation by Nepal Stock Exchange, establishment of Securities Central Depository Services Company, and Institutional Credit Rating Agency (ICRA)
  • Securities Markets Regulation: Securities market regulation is comprised of regulatory body and regulatory provisions to systematize the securities transactions. Securities Board of Nepal (SEBON) is the apex regulator of securities market in Nepal. It was established under Securities Act of 1984. The Securities Act of 1984 was later replaced by Securities Act, 2007. Besides, a number of other regulations are in place to regulate the securities market in Nepal. They include Securities Board Regulation, 2007; Securities Businessperson Regulation, 2007; Securities Registration and Issues Regulation, 2008; Mutual Fund Regulation, 2010; Securities’ Central Depositaty Services Regulation, 2010, Credit Rating Regulation, 2011; and many other byelaws, guidelines and circulars made by SEBON. The establishment of SEBON has facilitated to make securities transaction transparent and systematic to a greater extent despite of some complains on the effective implementation of the legal provisions and supervision by the regulator.
6. What is investment? What factors should be considered while investing in securities in Nepal?

Individuals can do any one of the two things with the income they generate: either they spend all income for current consumption or they consume part of income and save the rest for future better consumption. Thus saving is a sacrifice of current consumption with the hope of obtaining better consumption in future. However, the saving itself does not result into better consumption opportunity in future unless it is transformed into investment. Thus, investment in general refers to the allocation of current saving into productive opportunities with the expectation of generating additional wealth.

In other words, investment is the allocation of funds into productive opportunities that generate a positive rate of return. If investment is undertaken carefully it will end up with additional income or wealth that can contribute to the future better consumption. Besides rate of return, an investment requires the consideration about risk involved. Risk is the likelihood that investment will not yield positive rate of return. Thus higher the risk associated with an investment higher will be the required rate of return from such investment.

Factors to be considered while investing in securities in Nepal

An individual investor should consider several important factors in choosing among investment alternatives. They are described below.

  • Investment goal: Every investment should be guided by the investment goal. Therefore, the investor should consider her/his investment goal at the outset The investment goals may be appreciation in wealth, safety, liquidity combination of these goals. Generally, all investments are guided by the goal of wealth appreciation. Some of the goals are also dictated by the safety need and liquidity. The investment goal of investors always guides the selection of investment alternatives. Therefore, investor should establish her/his investment goal before making investment decision.
  • Risk and rate of return: Risk and rate of return are two closely associated factors in making investment decision. Every investment is undertaken to generate a positive rate of return. However, the rate of return expected from an investment must be consistent to the level of risk involved in investment. In other words, the rate of return expected from an investment must be sufficient to compensate against the level of risk involved in investing. Risk-return combination of investment alternatives must be consistent to the investment goal. For example, if the goal is to maximize wealth, the investor should select the risky alternatives because there is always a positive trade-off between risk and rate of return.
  • Tax consideration: Many investments are also dictated by the tax consideration. Taxes affect the rate of return from an investment. Some investments such as life insurance policies are tax exempted. Similarly capital gain returns are taxed at lower rate than the ordinary gains such as interest and dividend income. If the investor is in higher marginal tax bracket s/he may choose tax-exempted investment alternatives or the alternatives yielding higher capital gain. Similarly, the investors with lower marginal tax bracket may choose the higher yielding taxable alternatives.
  • Investment horizon: While selecting among the investment alternatives, the investor should also pay attention towards her/his investment horizon. If investors desire a consistent rate return over a longer period of time, s/he may choose long-term investment vehicles such as bonds. Similarly, if the investment horizon is short, the investors may go for short-term liquid investment vehicles such as Treasury bills.
  • Investment strategy: The investor should consider her/his investment strategy consistent to the investment goal before selecting investment alternatives. In considering the investment strategy, the investor should address the issues like investment selection, investment timing, and diversification. Investment selection is concerned with identifying appropriate investment categories and selecting appropriate securities in each category. Investment timing is concerned with configuring the right timing for buying and selling the securities. Generally investor should buy any investment alternative before its price will rise and sell before its price will decline. The issue of diversification is also important to minimize the investment risk. Generally,. a portfolio of investment must be well diversified by including different classes and categories of securities to minimize the investment risk.
7. Explain the steps in the investment process?

While deciding about investment, the investors should go through a systematic process. The investment process involves the following steps.

  • Determining investment objectives: An investor should clearly spell her/his investment objective before making investment. The investment objective is the motive that guides investor in choosing investment alternatives. Investment objective should be stated in terms of both risk tolerance and return preference. Simply stating investment objective as to make money is not enough. The investor should be clear why s/he needs to make money. It may be for children education or for retirement life or for safety and liquidity. Accordingly, the investor can go for the alternatives that best suit her/his investment objective. While determining investment objective it.should be noted that there may be more than one set of investment objective. For example, the investor may invest simultaneously for wealth maximization and liquidity. Similarly, the investment objective once set does not remain static rather it changes over the time as per the change in personal and family circumstances of investors. For example, a newly married couple may be aggressive and they want to assume any risk at the initial stage so their investment objective may be wealth maximization aggressively. However, in later years, with concern about children to educate and their own retirement life, the investment objective may be safety and liquidity without assuming enough risk for wealth maximization.
  • Developing investment plan: After setting investment objective, investor should develop formal investment plan consistent to the investment objective. The investment plan must specify the investor’s return preference, risk tolerance along with the period of investment.
  • Evaluating and selecting investment alternatives: There is wide range of investment alternatives available for investment. Each available alternative must be evaluated in terms of comparative risk-return relationship. The expected return and risk associated with each alternative should be preciously measured and they should be assessed in the light of investment objective. After the assessment of investment alternatives, the investor should select the suitable alternatives that best suit her/his investment objective. While selecting from among investment alternatives, investors should gather the information and use the information to select suitable investment vehicles. Along with risk return preferences, the Investors should assess the factors like tax considerations.
  • Constructing a portfolio: The investor should form an investment portfolio by including the securities that are qualified in risk-return, tax considerations and others. In constructing portfolio, the investor should pay attention to the diversification of risk. The portfolio of investment should maximize return and minimize the risk.
  • Evaluating and revising the portfolio: The securities included in the portfolio may not perform as predicted or may not satisfy the investment objective. Therefore, investor should make periodic evaluation of the performance of the portfolio. Some securities in the portfolio which stood attractive may no longer be so attractive. Thus, investors should delete such securities from the portfolio and add new ones that are attractive. Thus evaluating and revising the portfolio is an ongoing process.
8. A wide range of investment alternative is available to individual investors. Discuss.

The various investment alternatives available to investors are as follows:

  • Short-term securities: Short-term securities are of less than one year maturities. They are highly liquid, less risky and they yield lower return. The examples of short-term securities include Treasury bills, commercial papers, bankers’ acceptance, negotiable certificates of deposit, etc.
  • Common stock: Common stock is an ownership security issued by corporations. They are the most common investment alternatives for investors that give fractional ownership interest in the corporation. The holders of common stock receive dividend periodically as declared by the corporation. The common stockholders have later claim to the income and assets of companies than the claim of debt holders and preferred stockholders. Therefore, it is usually not fixed that whether the common stockholders receive dividend from the company. However, shares of common stock are the most actively traded securities in secondary market. The investors can sell their holding at any time in the market to reap the capital gains. Common stock as an investment alternative is most attractive to investors seeking for higher and faster returns as they are in active trading in the secondary market.
  • Fixed income securities: Fixed-income securities provide fixed return to the investors irrespective of the profit of the firm. They are popular investment alternatives to investors who prefer regular income. Some examples of fixed income securities are bonds, debentures and preferred stocks. A bond is long term debt instruments issued by governments or corporations. Investors who invest on bonds are entitled to receive periodic interest and return of the face value at the end of the maturity period of the bond. Government bonds are safer than corporate bonds hence offer lower return. Some bonds are convertible into a specified number of shares of common stock. Therefore, investors of convertible security have opportunity to receive fixed interest until the security is converted into common stock, and take advantage of price appreciation of stock by converting the convertibles into stock. A preferred stock represents fixed income securities that offer a fixed rate of dividend to investors.
  • Mutual Funds: Mutual funds companies sell their shares to public and create a large size public portfolio. The investors can invest in the shares called units of mutual funds. Mutual funds are professionally managed investment companies that offer a well diversified public portfolio to investors. Basically, the small investors with limited funds to invest, who can not form well diversified portfolio, can go thorough the investment in mutual funds units.
  • Derivative securities: Derivative securities derive their value from an underlying security. Derivative securities include several alternatives such as call and put options, forward and futures contract, swap, foreign exchange futures, commodity futures and so on. These securities basically represent an agreement or contract based on some other underlying securities. For example, a call option on shares of common stock is the derivative that gives its holders the right, not obligation, to buy underlying shares of common stock at pre specified price within stipulated time period. The value of this call option depends the value of underlying common stocks. Thus, it is called a derivative.
  • Other investment alternatives: Besides above mentioned securities, there are other investment alternatives as well. They include precise metals like gold and silvers; real estates, fine arts and collectibles, etc.

Long Question Answer

1. What does an investment plan consist of? What are the steps involved in investing? How do the considerations about taxes, life cycle of investors and different economic environment affect investment?

A comprehensive investment plan consists of systematic steps in investing and consideration of several factors such as tax consideration, consideration about life cycle in investment and different economic environment.

The systematic steps involved in investing are as follows:

  • Meeting investment prerequisites: Investors need to meet basic necessities of life such as making provisions for food, clothing and shelter, meeting emergencies, paying for taxes protecting against common risk of health and property and so on. Investors should make adequate provisions for these perquisites before investing.
  • Establishing investment goals: Investment goal refers to financial objectives that investors wish to achieve by investing. Before investing, investors should clearly state investment goals such as investment for retirement, or children’s education, or vacationing and so on.
  • Adopting an investment plan: Investment plan describes the actions needed to realize the investment goal. The investment plan must be consistent to investment goal. It should state rate of return expected, risk tolerance and the period of investment.
  • Evaluating investment: Evaluating investment means assessing the risk and return of the investment. All investment alternatives have different risk-return characteristics. Investors should use appropriate tools to measure risk and return for evaluating the investment alternatives.
  • Selecting suitable investments: The next step in investment is the selection of suitable investment alternatives that best meets the investment goals. In selecting suitable investment, Investors should assess expected rate of return, risk and tax considerations.
  • Constructing a portfolio: Investing in a portfolio offers advantage of risk diversification. Therefore, it is always advisable to invest in a portfolio.
  • Managing the portfolio: The securities included in the portfolio may not perform as predicted. Therefore, investors need to evaluate the performance of the portfolio against the investment goal. Under-performing securities should be deleted and new one be added into the portfolio.

An investment is affected by several factors such as considerations about taxes, life cycle of investment and different economic environment. Therefore, investors need to consider these factors while making investment plans.

Tax is an important consideration in investment planning. Therefore, an investor must be familiar with the prevailing tax laws and their implications on investment return. Tax rates affect the investment planning of an individual investor. For example, investors in the higher tax bracket prefer to invest in the tax-exempted investment vehicles such as tax exempted government securities. But investors in lower income level and lower tax bracket prefer the investment vehicles yielding higher rate irrespective to the tax exemption on income from their investment. Because of the severe impact of tax rate on investment income, the investor must evaluate every investment alternative in after-tax return basis.

Besides tax consideration, investors in general follow life-cycle approach while investing. It means that the investment strategy the investors follow differs at different phases of the life. Investors in early part of their life are often risk taking. They tend to prefer growth oriented alternatives like the common stocks of new companies and speculative securities like options and futures. As they approach middle-age, they shift to low-risk growth and income stocks, high-grade bonds, preferred stocks and mutual funds.

Finally, investors should also consider different economic environment that affect investment. For example, investors become aggressive during recovery and passive during decline. Similarly, investors generally invest in common stocks during growth phase and in bonds during decline phase.

2. Discuss the several investment vehicles available to an investor. Which of these are common in Nepal?

There is very limited range of investment alternatives available in Nepal. Some of the important alternatives are as follows:

  • Equity securities: Among equity securities, common stocks are the most popular investment alternatives. The market for preferred stock is very thin in Nepal. Only a few preferred stock issues have been outstanding.
  • Debt securities: Among debt securities, short-term government deb obligations like Treasury bills and long-term government debt obligations like National Savings Bonds, Development Bonds, and Citizen Savings Bonds issued by Nepal Rastra Bank are popular securities in Nepal. The market for corporate debt securities like debenture and corporate bonds is yet to grow in sizeable amount.
  • Real assets: Real assets like gold and silver are also popular to some extent i Nepal. In recent period, real estate investment has been emerged as the in popular value generating investment alternative. However, it is yet to regularize.
  • Mutual funds: In recent period, Nepal has opened the scope of mutual fund operation through enactment of Mutual Fund Regulation, 2010. As a good number of mutual funds such as NCM Mutual Fund, Citizen Unit result a Scheme, Nabil Equity Fund have come into existence among others.
  • Derivative securities: Trading on derivative securities like commodity futures are also emerging due to the establishment of commodity or derivative market in private sector. However, it is yet to regularize.

Common Investment Alternatives Available in Nepal

There is very limited range of investment alternatives available in Nepal. Some of the important alternatives are as follows:

  • Equity securities: Among equity securities common stocks are the most popular investment alternatives. The market for preferred stock is very thin in Nepal. Only a few preferred stock issues have been outstanding.
  • Debt securities: Among debt securities, short-term government debt obligations like Treasury bills and long-term government debt obligations like National savings bonds, development bonds, and citizen savings bonds issued by Nepal Rastra Bank are popular securities in Nepal. The market for corporate debt securities like debenture and corporate bonds is yet to grow in sizeable amount.
  • Real assets: Real assets like gold and silver are also popular to some extent in Nepal. In recent period, real estate investment has been emerged as the popular value generating investment alternative. However, it is yet to regularize.
  • Mutual funds: In recent period, Nepal has opened the scope of mutual fund operation through enactment of Mutual Fund Regulation, 2010. As a result a good number of mutual funds such as NCM Mutual Fund, Citizen Unit Scheme, Nabil Equity Fund have come into existence among others.
  • Derivative securities: Trading on derivative securities like commodity futures are also emerging due to the establishment of commodity or derivative market in private sector. However, it is yet to regularize.
2. What factors might an individual investor take into account in choosing among investment alternatives?

 An individual investor should consider several important factors in choosing among investment alternatives. They are described below.

  • Investment goal: Every investment should be guided by the investment goal. Therefore, the investor should consider her/his investment goal at the outset The investment goals may be appreciation in wealth, safety, liquidity combination of these goals. Generally, all investments are guided by the goal of wealth appreciation. Some of the goals are also dictated by the safety need and liquidity. The investment goal of investors always guides the selection of investment alternatives. Therefore, investor should establish her/his investment goal before making investment decision.
  • Risk and rate of return: Risk and rate of return are two closely associated factors in making investment decision. Every investment is undertaken to generate a positive rate of return. However, the rate of return expected from an investment must be consistent to the level of risk involved in investment. In other words, the rate of return expected from an investment must be sufficient to compensate against the level of risk involved in investing. Risk-return combination of investment alternatives must be consistent to the investment goal. For example, if the goal is to maximize wealth, the investor should select the risky alternatives because there is always a positive trade-off between risk and rate of return.
  • Tax consideration: Many investments are also dictated by the tax consideration. Taxes affect the rate of return from an investment. Some investments such as life insurance policies are tax exempted. Similarly capital gain returns are taxed at lower rate than the ordinary gains such as interest and dividend income. If the investor is in higher marginal tax bracket s/he may choose tax-exempted investment alternatives or the alternatives yielding higher capital gain. Similarly, the investors with lower marginal tax bracket may choose the higher yielding taxable alternatives.
  • Investment horizon: While selecting among the investment alternatives, the investor should also pay attention towards her/his investment horizon. If investors desire a consistent rate return over a longer period of time, s/he may choose long-term investment vehicles such as bonds. Similarly, if the investment horizon is short, the investors may go for short-term liquid investment vehicles such as Treasury bills.
  • Investment strategy: The investor should consider her/his investment strategy consistent to the investment goal before selecting investment alternatives. In considering the investment strategy, the investor should address the issues like investment selection, investment timing, and diversification. Investment selection is concerned with identifying appropriate investment categories and selecting appropriate securities in each category. Investment timing is concerned with configuring the right timing for buying and selling the securities. Generally investor should buy any investment alternative before its price will rise and sell before its price will decline. The issue of diversification is also important to minimize the investment risk. Generally,. a portfolio of investment must be well diversified by including different classes and categories of securities to minimize the investment risk.

Leave a Reply

Your email address will not be published. Required fields are marked *