Essay

The Most Important Terminology in Investment

Introduction

An investment is a monetary security purchased with the idea of creating more earnings in future or with the hope that the security will appreciate and be sold at a profit. The current paper will look at the most important terms in investment.

Asset Allocation

It is a term given to the investors’ investment strategy. Investors have three common classifications where they can put their money, i.e. cash, bonds, and stocks. When investors keep their securities in cash, it means they keep it in certificates of deposit (CDs), treasury bills, and money market accounts. Investment in bonds means an investor is loaning money to a company or government provided that nothing goes wrong during the investment period, for instance, bankruptcy. At the maturity period, the investor cashes the bond and collects interest. On the other hand, when an investor puts their portfolio in stocks, it is the case when the investor buys stock in a company. This makes the investor practically own the company. If the company performs well in the market, the investor’s share becomes worth more and vice versa.

Returns

This is an evaluation of a gain or a loss of an investment portfolio or security conveyed as a ratio of the endowed capital. Returns can be absolute or relative. Absolute returns look at the return of a particular asset in isolation while relative returns measure the return of a security against a benchmark. 

Mutual Fund

This is the abundance of funds that comes as a result of many investors investing in assets such as stocks and bonds. A mutual fund may hold some shares, with the aim of spreading risks. In many cases, money managers make buy or sell decisions for mutual funds. These decisions bring about an expense ratio, i.e. it always costs money to run mutual funds. For this reason, investors are expected to pay an annual fee referred to as the expense ratio. In other words, the expense ratio is the proportion of the investor’s money that goes to the managers of the mutual fund that the investor is investing in. The expense ratio covers other fund expenses, such as administrative fees, record keeping costs, and the promotion campaign fees of the fund.

Risk

Risk is the likelihood that the actual return on investment will be lower than the expected return. Investors fall under three categories of risk. There are also risk averse investors who will only go for the investments with small risks, risk neutral investors who will be interested in the returns they expect from their investment regardless of the risk, and risk-seeking investors will go for investments with high risks as they bring in more returns. There are two main classifications of risks, i.e. systematic and unsystematic risk. Systematic risk is the jeopardy that affects a massive number of assets. This type of risk cannot be escaped as it is beyond the control of the investors. This category of risk encompasses the market peril, political hazard, country hazard, default menace, economic risk, etc. On the other hand, unsystematic risk also known as the specific risk is the risk that affects a percentage of assets but not the whole selection of assets. This risk can be controlled by investors through a process termed as diversification.

Diversification is a risk management tactic that mixes a variety of investments within a portfolio. A portfolio is a combination of assets or securities. The concept of diversification is that a collection of different kinds of securities will averagely bring about higher returns and pose a minimal risk in contrast to a single security in the portfolio. Diversification aims at getting rid of the unsystematic risk in a portfolio so that a positive performance of some assets can neutralize the negative performance of other assets. For diversification to work perfectly, the returns on the investments must be negatively correlated.

Working Capital Management

This is a slant focusing on the conservation of effectual echelons of both mechanisms of working capital that are, considering current assets and current liabilities, in high opinion to one another. Working capital administration makes sure that a firm has adequate cash flows to meet its short-term responsibilities and other functioning overheads. If a company upholds an effective working capital management, it improves its earnings. Ratio analysis and managing of individual components of working capital are essential features of working capital management as they help in the pointing out of areas where management should focus on, such as stock management, cash controlling, accounts receivable and payable supervision. The main ratios include working capital ratio, inventory turnover ratio, and the collection quotient.

Capital Budgeting

This is a crucial decision of a business as investment choices either make a firm prosper or fail. Capital decisions take time to mature as they are based on the returns that the investment will make. When making decisions, the projects to be undertaken are recognized and then the management initiates the financial process of defining the most lucrative project to be pursued. There are three main gears to be used in decision-making; they entail the payback period, net present value (NPV), and the internal rate of return (IRR). The project with the shortest reimbursement period, highest NPV, and with an IRR that is greater than the cost of finance should be undertaken.