After studying this text the learner should / should be able to:
- Elucidate the categories of investments.
- Distinguish the investments of the financial system.
- Differentiate the non-financial investments.
- Describe the investments of the investment vehicles and their underlying investments.
- Elucidate the asset classes.
This main section on "Investment instruments" is preceded by the main sections:
- Four phases of the life-cycle.
- The financial system.
It is followed by the main section "Investment principles". In the preceding main sections we differentiated the two categories and the subcategories of investments:
- Ultimate investments:
- Financial investments instruments (issued by ultimate borrowers):
- Debt instruments.
- Share (aka stock and equity) instruments.
- Real investments:
- Property (also called real estate).
- Other real investments (art, rare coins, antique furniture, etc.).
- Indirect investment instruments (issued by financial intermediaries):
- Issued by banks: deposit instruments.
- Issued by quasi-financial intermediaries: debt instruments.
- Issued by investment vehicles: participation interests.
Investors hold the ultimate investments either directly or indirectly by holding the securities of financial intermediaries. This of course means that while they invest in the securities of the financial intermediaries, they ultimately are holding the ultimate investments. The financial intermediaries essentially facilitate this, for example by accepting small amounts of funds from individuals; they also offer diversification in the investment, a vital principle in investments (i.e. a risk management tool as we shall see later).
Many individuals do hold ultimate investments in the form of shares. Almost all individuals hold bank deposits. However, the majority of individuals hold the majority of their assets in the securities [recall that we refer to their securities or products collectively as "participation interests" (PIs)] issued by the investments vehicles (ignoring property for a moment). The investment vehicles are as follows:
- Contractual intermediaries (CIs):
- Retirement funds.
- Life insurers (note: only endowment policies & annuities are investments).
- Collective investment schemes (CISs):
- Securities unit trusts (SUTs).
- Property unit trusts (PUTs).
- Exchange traded funds (ETFs).
- Alternative investments (AIs)
- Hedge funds (HFs).
- Private equity funds (PEFs).
As noted, PIs are the liabilities of the investment vehicles; they are the instruments which are held by the individual investors. On the asset side of the investment vehicles' balance sheets are the ultimate investments. The investment vehicles exist to facilitate the investment by individuals (and some retirement / other funds) in the ultimate investments. They reduce transactions costs (which are high with ultimate investments) and manage investments on behalf of investors in Pis.
Figure 1: financial intermediaries & instruments (securities) (simplified)
We also differentiated the financial markets of the financial system as follows:
- Short-term debt market (STDM + the deposit market = money market).
- Long-term debt market (LTDM ; marketable part = bond market).
- Shares (listed shares = share market; unlisted shares).
- Forex market (no lending and borrowing; therefore no investment instruments).
- Derivative markets (futures and options can be used as substitutes for investments).
All the investments instruments can be depicted as in Figure 1.
We have given the financial system and its markets most of the attention thus far - because they deliver the investments most favored. In this main section we cover the detail of these investments, as well the detail of the real investments, which are held to some degree by investors. We cover them under the following sections:
- Time value of money.
- Money market instruments.
- Bond market instruments.
- Share market instruments.
- Derivative market instruments: futures and options.
- Real investments.
- Investment vehicles.
- Foreign investments.
- Asset classes.