Monday, March 1, 2021

ELEMENTS OF INVESTMENT

(Source: Investment Law Teaching Material

Tesfaye Abate)

There are three factors that are considered as elements of investment.

a) reward (return); b) risk and return; and c) time.[1]

A. Reward

We have seen above that investment is made with the intention to gain profit. Thus, investors, generally, may expend their fund to earn a return on it. The return is known as reward from the investment, and it includes both current income and capital gains or losses which arise by the increase or decrease of an investment.

Let’s say, Ayal has started producing bread in a modern way at Arat Kilo and distributes it to the customers in Addis Ababa. The capital for the investment is Birr 10,000. She invested on the sector with the expectation of profit. Moreover, let us assume that she has got Birr Two thousand within six months of her investment. This is a reward from the investment.

B. Risk and Return

he second element of investment is risk and return. Risk may be defined as the chance that the expected or prospective gains, or profit or return may not materialize. It also includes the fact that the actual outcome of investment may be less than the expected outcome. It is important to not that the greater the variability or dispersion in the possible outcome, the greater the risk will be.

 

In addition, risk means estimation about the degree of happening of the loss. Risk and return are inseparable. Return is an expected income from the investment. It represents the benefits derived by an investor from his/her investments. The rate of return required by the investor largely depends on the risk involved in the investments. Thus, the investment process must be considered in terms of both aspects of risks and return. Risk can be quantified by using precise statistical techniques. Therefore, risk is a measurable element. 

Example: Hailu has invested on flower on the road to Jimma. He must assess the risks involved in the investment. For instance he should consider the possible pests that may cause damage to the flower, the risk of the market failure, the risks involved in transporting the flower to Bole, and then the air transport to export it to foreign countries and so on. On the other hand, Hailu should estimate the expected return, i.e. profit from the investment. We have seen that risk and return are inseparable. Thus, Hailu should consider both the risks and return of his investment together.

 

C. Time

 

Time is the third element of investment. It offers several different courses of action. Conditions change as time moves on and investors should re-e valuate expected return for each investment.

An investment could not be materialized within a very short period of time. In other words, investment is of long-term in nature. For example, if one needs to invest on a cement factory, s/he should conduct market research to ensure the viability of the investment. Conducting research needs a certain period of time. After the research is done, machineries should be imported and installed. This also is to be done through time. Then, the factory should produce sample cement, distribute the product, and collect the feedback from the customers. Then, the factory would start production and distribute cement to customers. All the above-mentioned activities need to be done through time.

 

Let us consider another example. Almaz wishes to invest on the textile. First, she saved a certain amount of money, and let us also assume that she was granted a loan from the Commercial Bank of Ethiopia. Secondly, she has to import necessary machineries from, say, German, Italy or any other country. The machineries should reach Ethiopia and an installation is necessary. Then, the factory starts production. The production process needs a certain period of time. In general, investment by its very nature is of a long-term process. During this time, the investor has the opportunity to re-e valuate the risks involved in that particular investment, and take necessary measures to minimize the degree of risk.

 

Further, investment requires a continuous flow of decisions. As we can observe from the above examples, the investors should decide on each and every level of the investment. Thus, investment is the result of a series of decisions.

 

Moreover, investors should from time to time reappraise and revaluate their various investment commitments in the light of new information, changed expectations and ends.

 

Investment decisions are based on data which represent the observable environment and the general and specifics of a given investment. It takes the ability to analyze the data and specifications properly to make an appropriate decision. Thus, investment is the result of a series of decisions.

 

Thus, investment is an art and depends on the art the individual investor employs to be successful. An investment may be successful where the investor employs a suitable art. On the other hand, investment is a science because there are rules and principles developed through time. In general, investment is an art and a science.

 

[1] V.  Gangadhar and Ramesh Babu; Investment Management including Portfolio Management And Security Analysis,  Anm Publications Pvt, Ltd, New Delhi,  2003, Pp. 3

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