SUBJECT: - SPECIAL STUDIES IN FINANCE

PROJECT: - GUIDELINES FOR GOOD

INVESTMENT DECISION

STD: - TY B. M. S. DIV: - B

SUBMITTED TO: - MRS MINAL MAM.

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 ACKOWLEDGEMENT

We feel immense pleasure in appreciating our one of the

dearest prof. “MINAL MAM” for assigning such a wonderful and
knowledge base project on SPECIAL STDIES IN FINANCE .

This project has widened horizon to various areas under

general knowledge regarding to the pie. Last but not the least, this
project has definately helped to achieve something. This will be useful
in our near future. Thank you MaaM!!!!!!!

INTRODUCTION
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Investment policies have given a new perspective to the role of financial
administration, this has made the topic is of interest to all scholars and lovers of
finance

Investment decisions are a major financial decisions, all decisions relating to

business investment from the analysis of investment in working capital such as
cash, banks, accounts receivable, inventory and investment capital represented in
fixed assets such as buildings, land, machinery, technology etc.

To make the right decisions the financier has to take into account elements of
assessment and analysis as the criteria for analysis, cash flows associated with
investment, the investment risk and rate of return required.

INVESTMENTS DEFINED
An investment is a commitment of funds, for a period of time, in order to derive an
increased future flow of funds. It is intended that the investment will:
• return the invested principal;
• provide, through interest, dividends or capital appreciation, a real return to the
investing unit for the time other funds are committed;
• provide compensation for inflation; and
• provide compensation for the business, market and liquidity risks involved in the
investment.

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 TYPES OF FUNDS
Unrestricted funds are those funds which can be used for any purpose allowed
by the organization’s charter, articles of incorporation, bylaws or other documents.

Designated funds are unrestricted funds that the organization’s governing

board has chosen to direct to a particular use.

Restricted funds are funds whose use has been limited by the donor, General
Conference or another appropriate body. Such restrictions may limit the types of
investments and the ability to use the principal and income to fund expenditures.

Endowment funds (also known as permanently restricted funds) are funds for
which the corpus or principal is to be invested on a continuing basis. Depending on
the wording of the instrument establishing the endowment fund, all or a portion of
the income and capital gains may be available for expenditure.
Endowment fund restrictions often include phrases such as “the income
(or income only) shall be distributed to...” Unless explicitly specified to the
contrary or otherwise mandated by law, “income” in such phrases should be
interpreted to mean that combination of interest, dividends and capital appreciation
that can be withdrawn on a continuing basis without reducing the purchasing
power of the original endowment principal. A determination of the appropriate
amount of “sustainable income” will need to be made in administering such funds.

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 ELEMENTS OF AN INVESTMENT
POLICY
The following elements or themes of an investment policy are required for general
agencies and are recommended for all organizations associated with The United
Methodist Church:

1. Investment Strategy
Define the investment objectives. Identify the assets under management, the
expected receipts and disbursements and any obligations imposed by the donors;
classify the assets as “current funds” or “non-current funds” and allocate them
among asset classes as appropriate to the investment strategy.

2. Investment Management Consultant

Select a qualified investment consultant from the staff of the agency, a United
Methodist Foundation or from a licensed professional firm. Establish a specific
agreement defining the terms and conditions of the relationship.

3. Spending Policy
• Spending policy, asset allocations, asset class optimization and written
investment policy are all inter-related.
• Spending policy determines how much will be spent currently versus how much
will be invested to provide future spending.
• Well-defined spending policy leads to better investment policy and improved
long-term investment results. Spending policy must consider “real return” after
inflation.
Sample Spending Policy Formula.
Estimated Annual Rate.
Estimated Portfolio Return 8.5%.
Less Inflation 3.0%.
Less Admin. Costs 1.0%.
Less Desired Portfolio Growth 0.5%.
Equals Spending or Distribution Level (Target) 4.0%.

4. Asset Allocation

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Asset allocation is the one most important decision of investment policy. Over
90% of long-term variance can be attributed to asset allocation. Once spending
(distribution) targets are established we can consider capital markets history,
tolerance for risk (the fiduciary’s most important decision), time horizon for the
investments and then (only then) can we begin to construct the portfolio that will
provide our target return with the lowest risk.

 What We Know:
Capital market history
• Historical returns of asset classes.
• Historical variability of returns of asset classes (standard deviation).
• Historical correlation between asset classes.

 What We Decide:
Investment policy
• Return expectations.
• Risk tolerance.
• Asset class preferences and allocation constraints and restrictions.
• Time horizon to meet objectives.
• Economic forecast of product and capital markets.

 What We Conclude:
• Portfolio optimization.
• Efficient frontier of optimal portfolios.
• Expected returns at given levels of expected risk.
Well written asset allocation policies will include policies and parameters for
periodic rebalancing of the asset allocation. Portfolios should be rebalanced first
with cash inflows/outflows in a manner consistent with the strategic allocation of
the fund. If there are no cash flows, policy should provide the committee with
procedures for periodic (quarterly) review and rebalancing.
Established minimum and maximum exposure to the assets classes listed below:
Cash equivalent ____% to ____%
Bonds ____% to ____%
Equities ____% to ____%

5. Investment Diversification

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The diversification of investments is recognized as an important consideration in
the control of risks associated with investing. Diversification of asset classes and
diversification within an asset class are primary objectives in the structuring of the
portfolio.

6. Security Selection
The stock portfolio is to be diversified so that the performance of one company
does not significantly affect the performance of the portfolio.The portfolio is to
maintain a reasonable diversification across industry sectors, so that the
performance of any one sector does not significantly affect the performance of the
portfolio.
The bond ratings as rated by the Standard and Poor’s or Moody bond rating service
or its equivalent for fixed-income investments (bonds and notes of the U.S.
government and its agencies, U.S. corporate bond issues) must be considered. The
portfolio shall be diversified to the extent that no one corporation’s bond issue will
represent a significant portion of the total bond portfolio.
Cash equivalent investments (less than 1 year fixed income vehicles) will
have a quality restriction. Commercial bank balances that exceed FDIC insurance
levels should be considered to be of lower quality and subject to a cap.
Restrictions from engaging in dealing with security options, margin trading, short
selling, of securities must be considered.

7. Monitoring
Monitor all portfolios on a periodic basis by both staff and the board of the agency.
The board may appoint an investment committee to carry out this function for the
board. This monitoring should include an evaluation of the performance of
invested funds as well as the accomplishment of objectives within the policies and
guidelines established.
Set criteria for the investment manager search and evaluation process. Interview
candidates for the management of each specific asset class. Review the specific
objectives and policy constraints for each manager. Set standards for
communication, service and the performance benchmarks by which investment
managers will be evaluated.

A. Investment Performance versus Policy Objectives:

• Performance measurements should be evaluated.
• Net of all management fees, brokerage and custodial expenses.
• Annualized and time weighted considering all deposits and withdrawals.
• Within the policy constraints and guideline.

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B. Investment Performance versus Spending Policy:
The total returns from investment activity must be evaluated net of all cost to the
entity, including the entity’s administrative expenses and payout to fund ministry.

C. Risk Adjusted Performance Analysis and Market Comparison:

Relative performance measurement compares the portfolio returns versus the
financial market and the economic climate. Financial and economic benchmarks
should be documented in the investment policy statement. Risk adjusted
performance evaluates the volatility of portfolio returns around the mean
performance over time.
Several different statistical measurement tools should be used to evaluate
performance behavior in this area. Examples include:
• Standard deviation or volatility of returns, (mean-variance) “scattergram
charts”.
• “Downside risk” or semi-variance returns.
• Manager beta, alpha, and correlation of returns to the benchmark index.
• Manager return correlations to asset class benchmarks.
• Many of those tools are used in portfolio optimization and asset allocation
analysis to lower expected risk and maximize expected returns.

D. Individual Manager Performance versus Benchmarks and Manager

Universe:
Evaluate the managers’ performance versus specific benchmarks set forth in the
investment policy statement. Managers should be evaluated versus appropriate
“style” benchmarks over 3, 5 and 7 year periods.

E. Investment Activity must be within Policy Guidelines:

All investment activity should be within the constraints and guidelines of the
investment policy document.

F. Social and Moral Goals

Assure that the elected membership, staff and consultants of an organization are
aware of and sensitive to the religious, social, ethical, and moral aspects of
investing and that investment judgments contribute to a positive social impact and
to the correction of societal inequities. The use of divestment, selective investment,
stockholders’ actions, correspondence, visitation, or symbolic acts is encouraged
when feasible, prudent, and proper in the accomplishment of moral and social
goals established by the General Conference of The United Methodist Church.

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 SOCIAL GUIDELINES
The organization, responding to the biblical challenge of responsible stewardship,
calls for conscious investment decisions that further the principles of economic and
social justice consistent with the goals outlined in the Social Principles of The
United Methodist Church. Thus, the goals for the investment of the Fund are to
influence corporate policy and public conscience in the promotion of peace, human
rights, justice and the respect for and quality of life for all persons. A basic tenet of
the investment and capital formation and growth strategies undertaken by the
Fund shall be to foster and advance business practices and activities which reflect
the Social Principles of The United Methodist Church. All investment managers
shall exercise their best efforts to place investments in ways that make a positive
impact. Investment managers shall be guided by the following ethical norms
according to the Social Principles of The United Methodist Church:
• An ecologically just world and a better quality of life for all creation;
• Social justice and the sacred worth of all persons;
• Sound fiscal policies that protect the economic life of all individuals;
• Political and governmental responsibility for protection of basic rights; and
• The unity of the world community
Any conflicts of values shall be resolved with discretion, fiduciary responsibility,
and appropriate consultation.
With regard to socially responsible investing, the investment management
of the Fund shall be a process of avoidance; that is, by avoiding investments in
companies with policies or products that may harm society, either individually or
corporately, in one or more ways. This investment process of avoidance primarily
serves to reduce the universe of securities in which to invest by screening
companies for socially undesirable characteristics. The committee may, from time
to time, direct the investment managers as to specific investments or types of
investments considered to be inappropriate for the Fund. Although the socially
responsible investment process implemented for the Fund is not anticipated to
present a trade-off of risk or return as compared to the market, the organization
and the committee remain committed to the imperative of the avoidance of
investments that appear likely, directly or indirectly, to support any of the social
ills listed herein. Every opportunity shall be taken to further shareholder advocacy
to further the goals outlined in the Social Principles of The United Methodist
Church, including advocacy of disinvestment.

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 Social Responsibility Guidelines

As an agency of The United Methodist Church we are committed to implementing

716 of
The Book of Discipline.
Socially Responsible Investments – It shall be the policy of The United Methodist
Church that all general boards and agencies, including the General Board of
Pension and Health Benefits, and all administrative agencies and institutions,
including hospitals, homes, educational institutions, annual conferences,
foundations, and local churches, shall, in the investment of money, make a
conscious effort to invest in institutions, companies, corporations, or funds whose
practices are consistent with the goals outlined in the Social Principles; and shall
endeavor to avoid investments that appear likely, directly or indirectly to support
racial discrimination, violation of human rights, sweatshop or forced labor,
gambling, or the production of nuclear armaments, alcoholic beverages or tobacco,
or companies dealing in pornography. The boards and agencies are to give careful
consideration to shareholder advocacy, including advocacy of corporate
disinvestment.

INVESTMENT RETURNS
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 The Uniform Prudent Investment Act states that we are to view
investments from a total return perspective, which includes interest, dividends, and
capital appreciation. Investment returns consist of three elements:

1. A risk-free return for the use of the capital over the short term. U.S. Treasury
Bills (mature in one year or less) are considered risk-free and their yields represent
a reasonable indicator of this risk-free return.

2. Compensation for the rate of inflation. The usual annual inflation rate varies
from about 2.5% - 4%, although there have been some periods of double-digit
inflation. Note that an expected rate of inflation is usually implied when the
investment is undertaken. If the actual rate of inflation is higher than the expected
rate of inflation the real return is reduced and may become negative.

3. A risk premium. The risk premium depends on the degree of risk and the
maturity of the security. For currency investments (cash and near-cash) there is a
modest interest return on U.S. bank deposits, certificates of deposit and money
market funds; for foreign currencies the total return is dependent on the exchange
rates relative to the U.S. dollar that prevail when the currency is bought or sold.
For debt investments (bonds) held to maturity, the nominal return is determined by
the interest rate established when the investment was made. When a bond is called
before maturity at a premium (discount) there is a capital gain (loss). When a bond
is sold before its maturity, there is a capital gain (loss) if the current market interest
rate is lower (higher) than the original interest rate.
The “Rule of 72” provides a quick means to understand the importance of
the interaction between the rate of return and the duration of the investment. It is as
important to assure a sustained investment program as it is to gain a good annual
rate of return: An investment in a typical: at: doubles in:
Interest-bearing Deposit 2% 72/2 = 36 years
U.S. Treasury Bill or CD 5% 72/5 = 14.4 years
High Quality Bond 7% 72/7 = 10.3 years
High Quality Stock 10% 72/10 = 7.2 years

INVESTMENT RISKS
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Investment risk is simply the uncertainty of the future value of a security or a
portfolio. The most common measure of risk is the standard deviation or dispersion
of the actual past investment return from the expected average return.
The following concepts reflect the reality of risk and the practices that can be used
to minimize and manage risk:
1. Long investment horizons involve greater uncertainty than short ones;
2. Different asset classes involve different levels of risk;
3. Diversification among securities in a single asset class and among different asset
classes will reduce overall portfolio risk;
4. Investment risk can be managed by diversifying the asset allocation of a
portfolio.
The conditions that generate uncertainty about the future value of a security are
business risk (e.g. default of the issuer), financial risk (non-diversifiable risk and
the maturity of the security), speculative risk, liquidity risk (due to the necessity to
find a willing buyer) and more general investor outlook and confidence in the bond
and equity markets. Committees should also give careful consideration to an
appropriate risk level. A high level of expected return (whether of income or
capital growth) may mean that the investment manager will need to take some big
chances which, in hindsight, the sponsors may regret.

Business Risk
The greatest risk associated with the debt security is the risk that the issuer may be
unable to fulfill the obligation to make periodic payments of interest or be unable
to repay the principal when due. The greatest risk associated with an equity
security is that the issuer will be unable to pay dividends or to sustain and enhance
the value of the stock. The general perception of these risks is reflected in the
price/earnings ratio for stock and in the ratings of bonds by Moody’s and Standard
and Poor’s.

Bond rating Description

Aaa or AAA Highest quality, lowest default risk
Aa or AA High quality
A Upper medium grade
Baa or BBB Medium grade
Ba or BB Lower medium grade B, C or D Speculative, high default risk.
The bonds in the four highest rating categories are known as “high-grade” or
“investmentgrade”,
meaning that financial risk is relatively low and the probability of future payment

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relatively high. Lower rated bonds have speculative elements, and the repayment
of principal and interest in accordance with the terms of the bond issue are not
ensured. Note that bonds below medium grade are often called “junk” bonds.
Bonds issued by government or quasi-government entities offer reduced risk if
they are issued with the “full faith and credit” of the issuer or are supported by a
specific commitment of revenue.

Maturity Risk
An investment for a short period of time carries less risk than one for a long period.
Thus short-term instruments generally carry a reduced risk premium and provide a
reduced return.

Speculative Risk
The selection of a security on the perception that it is underpriced introduces
additional uncertainty of future value because it assumes that the available data
about the security is inaccurate or incomplete.

Liquidity Risk
Some assets and securities are not readily saleable. If there is not an established
market and a known price range, a delay in the sale and reduction in selling price
may be required to find a buyer.

Diversifiable and Non-diversifiable Risk

Each security involves some uncertainty about its future value apart from the risks
inherent in the investment marketplace. The risk in a specific security is
diversifiable and can be reduced by diversification. The uncertainty inherent in the
investment marketplace is nondiversifiable.
Broad asset classes may be further divided. Each asset class – broad or narrow – is
associated with a specific level of risk, so the allocation among classes generates a
pattern of returns related to risk.

Market Risk
Economic conditions, international events and political conditions may induce both
favorable and unfavorable changes in the security values apart from the merits of
the individual issuesand the issuer. Market risk is expressed by price changes and
interest rate changes in stocksand bonds and exchange rate changes in currencies.

FINANCIAL INSTRUMENTS
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 Current funds may be held in a checking or savings account.
Since they earn little or no interest the amount of such balances should be carefully
adjusted to provide funds only for immediate and near-term needs. There are
several ways of investing non-current funds. They can be invested in fixed-income
short, medium, and long-term securities, in equity instruments or in any of the
asset classes.
The advantage of using investment grade financial assets as vehicles of the
investment (as compared with real estate or other tangible personal property) is
that investment grade financial assets have a broad-based market for their
evaluation, purchase and sale. The contents of a portfolio depend on the interaction
of three elements: investment objectives or goals, the plan for meeting those
objectives and the selection of specific securities that are permitted under the social
stance of The United Methodist Church.

1. SHORT TERM INVESTMENTS

For the portion of funds that may be needed on short notice,
investments should usually be limited to short term securities:

 Cash. U.S. dollars offer high liquidity, low or zero risk but very low or zero
returns.

 Money Market Securities. Most short-term securities are fixed-income

money-market securities (no equities) having a remaining maturity of up to
one-year (including securities originally issued for longer periods) and are
actively traded in financial markets.

 U.S. Treasury Bills. Treasury Bills are United States government

obligations issued in 90 day, 180 day, and 360-day maturities. They are
issued at discounts, at $10,000 face value and may be purchased by auction
at Federal Reserve Banks or in the open market.

 Commercial Paper. Commercial Paper is an unsecured promissory note

issued by banks and corporations. It is generally issued on a discount basis
with maturities of 270 days or less and backed by bank lines of credit to
reduce the risk of default. Almost all commercial paper is rated with respect
to credit risk by one or more of several rating services. Moody’s, Standard
and Poor’s or Fitch Investors Service. Yields on commercial paper are often
comparable to those on certificates of deposit and bankers’ acceptances with
similar maturities.
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  Certificates of Deposit. Certificates of Deposit (CDs) are deposits placed in
banks and savings institutions at a stated rate of interest. CDs have an
original maturity of 1 to 12months but some are available for longer periods.
CDs issued by a FDIC member are insured by the FDIC up to $250,000 per
depositor.

 Negotiable Certificates of Deposit. Large deposits ($100,000 or more),

unlike regular CDs, qualify as money market instruments because they have
short maturities, low default risk and are reasonably marketable.

 Bankers’ Acceptances. Bankers’ Acceptances are short-term, non-interest-

bearing time drafts (promissory notes) sold at discount and redeemed by the
accepting bank at full face value. Bankers’ Acceptances carry the issuer’s
pledge (the issuers are usually too small or too risky to use Commercial
paper), are backed by the underlying goods being financed, and carry the
guarantee of the accepting bank.

 Repurchase Agreements. Agreement between a seller and a buyer, usually

of U.S. Government securities, whereby the seller agrees to repurchase the
securities at an agreed upon price and usually at a stated time.

2. MEDIUM AND LONG – TERM INVESTMENTS

Medium-term securities have maturities of one to ten years and
include securities originally issued for longer periods. Long-term securities have
maturities up to 30 years. Securities are first sold in the Primary Market as Initial
Public Offerings (IPOs) and then sold on the security exchanges in the Secondary
Market.

3. FIXED INCOME CAPITAL MARKET SECURITES

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 U.S. Treasury Issues. Treasury Notes are issued with maturities of one to
ten years; Treasury Bonds are issued with maturities of up to thirty years.

 STRIPS (Separate Trading of Registered Interest and Principal of

Securities). Under the U.S. Treasury STRIPS program, selected Treasury
securities are available as separate interest and principal payments. Thus a
long-term, default-free, non-callable zero coupon bond is available.

 U.S. Agency Securities. All securities issued by the federal agencies have
implied backing from the federal government. However, only those of a few
agencies are explicitly backed by the full faith and credit of the United States
government. There is slightly more risk involved with those federal agency
securities not having the full backing of the United States government than
with T-Bills. The maturities are normally longer than one year.

 State and Local Government Obligations. Municipal issues are bonds sold
by states, counties, cities and other political entities. Interest is excluded
from federal income tax and state income tax in the state of issue. General
obligations are backed by the full faith and credit of the issuer and repaid
from taxes. Revenue obligations are sold to finance a particular project and
are repaid from the income earned on the project. There is a wide range of
risk, maturity and marketability in municipal obligations.

 Corporate Issues. Corporate bonds are usually issued as term bonds with
maturities of five years or more. They pay interest (either at a fixed rate or a
floating rate referenced to an index rate) and principal at specified times.
The corporation may have the right to call the bond and the bondholder may
have the right to convert the bond into the corporation’s common stock.
They are riskier than government securities and offer a higher interest rate,
which depends on the creditworthiness of the issuer.

 Asset-Backed Securities and Pass-throughs. Asset-backed securities are

created by combining many individual issues such as home mortgages into a
new security. Mortgagebacked securities have low default risk but are very
sensitive to interest rate changes. As payments of interest and principal are
made by the lenders, the proceeds are “passed-through” to the security
holders,

 Collateralized Mortgage Obligations. Mortgage-backed bond that

separates mortgage pools into different maturity classes, called tranches.
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 4. EQUITY SECURITIES

 Preferred (or preference) stock. Preferred Stock pays a fixed annual

dividend but only if corporate income is sufficient to do so. Cumulative
preferred stock must pay any past unpaid dividends before any payments can
be made to common stock.

 Convertible Notes and Bonds. Notes and bonds which are convertible into
common stock.

 Convertible Preferred Stock. Preferred Stock which is convertible into

common stock.
Revised 2/17/2009.

 Common (or ordinary) Stock. Common Stock represents the ownership of

a corporation. Shares of common stock give the right to any assets after all
creditor, debt and preferred stock claims have been satisfied.

 International Equities. International equity issues are foreign common

stocks. They have similar features to U.S. issues but also some very special
features in different countries. Shares may be purchased in the home country
or, if listed in two or more countries, may be purchased on U.S. exchanges.
American Depository Receipts (ADRs) represent shares held by a U.S. bank
and available for purchase in the secondary market.

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 BIBLIOGRAPHY

1. INTERNET:

 Google.
 Yahoo.

2. BOOKS:

 Vipul prakashan.

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