INVESTMENT CONCEPTS

COMPONENT 1

INVESTMENT CONCEPTS

1.1 INTRODUCTION

A burning question on the minds of many people is: “How do I become

wealthy?” Google will guide you to numerous lists and steps that you have to
follow in order to become wealthy. Many sources suggest that great wealth is
destined for those who excel in the sports arena, are great entertainers or
have been successful entrepreneurs. The majority of people, however, do not
necessarily fall into one of those categories. As a salaried employee, chances
are very good that they might never accumulate great wealth just on that
salary. Sound investments, however, provide the potential to accumulate
great wealth.

Investment does not imply speculation or gambling. Persons earning a fixed

income often view the activities of investors, mainly due to their ignorance, as
speculation and/or gambling. Furthermore, a specific decision, for example,
the decision to purchase a cottage at the coast, could be an investment
decision for one person whereas it could be a decision to speculate for
another. It is, therefore, important to distinguish between gambling,
speculation and investments.

Gambling is when a person makes a decision/execute an activity without any

knowledge of what the outcome will be. A person pushing down the lever of a
gambling machine knows that the possibility of a large return exists, but has
no idea of when it might happen. “Experts” playing the machines will claim
that a certain machine is “hot”, but it is all only guesswork and the majority of
persons occupying themselves with gambling activities never become rich. On
the contrary, the living standard of most of them deteriorates.

Speculation is when a person ventures his money (and often also other
people’s money) on an activity (for example the purchase of a cottage at the
sea or of shares) with the expectancy of a large return after a very short time
period. There is a degree of knowledge applicable here. The person has most
probably studied numerous similar transactions and realises that the price of
the cottage at the sea could double within a year or two due to its location.
However, the property market can fold and the person can suffer a
considerable loss within a year. Speculation holds the promise of great
returns, but it is very risky.

Investments consist of the purchasing of assets with the purpose of retaining

it for a considerable period of time so that it can increase in value and/or
provide a reasonable return for the investor. The investor will therefore
purchase the cottage at the coast expecting that the value will double over the
next few years (five or ten years). At the same time, he can also earn an
income from letting the property.

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A distinction can be made between speculation and investment on the basis

of two aspects, namely:

❖ the term
❖ the motive

With speculation, the idea is to realise the return within a short period of time
(a few months or at most a few years). With investments, the minimum time
period will be at least five years. The minimum term of five years is applicable
for most investment instruments of the insurance and banking industry. When
speculating, the motive is to realise a considerable return/profit on the original
investment, whereas the investor will be satisfied with a reasonable/fair return
on his investment. What should be considered as a fair or reasonable return
will differ from investor to investor. Some would view a return equal to the
inflation rate as reasonable, whereas others would consider a real return of
5% or 10% as reasonable. Real return is the return after inflation has been
considered, i.e. the actual (nominal) return less an expected inflation rate.

1.2 INVESTMENT OBJECTIVES

Why do individuals and enterprises invest? Various reasons can be identified,

and not all investors invest for the same reason. The most important reasons
for investing are:

➢ Speculation
➢ Income
➢ Capital growth
➢ Take-overs and mergers
➢ Control over a raw material/distribution channel

Although speculation is not viewed as a pure investment decision, it is one of

the main reasons why assets (investment instruments) are acquired. The
investor purchases the asset (property, shares and/or options) with the
purpose of selling it within a short period of time (a few months) at a
considerable profit. The risk during speculation is high as the value of the
asset can decrease over the short-term. Furthermore, if the speculator
purchases the asset with borrowed money, his loss and financial dilemma will
be so much bigger. But if the asset increases in value (as expected), then the
decision to speculate could provide a substantial return.

Some investors acquire assets purely for the income that it will generate for
them. Property is purchased for the rent that it will provide, shares for the
dividends and fixed deposits for the interest. Especially elderly people and
persons that are retired are interested in the return that certain investment
instruments will provide.

A third reason is to obtain capital growth. Capital growth implies that the
original investment eventually increases. A person could purchase a
property at R600 000 and after 10 to 15 years that property could be sold for

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R1 million. The investment achieved a capital growth of R400 000. It is on this

capital growth that South Africans have to pay capital gains tax. The reason
why investors seek capital growth is to protect the purchasing power of their
money. They therefore try to obtain a capital growth that will at least equal the
present inflation rate. The R400 000 capital growth mentioned above sounds
satisfactory, but after 10 years you can probably only purchase the same
quantity of goods with R1 million as you could have purchased previously with
R600 000 (due to the effect of inflation on the purchasing power of capital).

A further investment objective is that of take-overs and mergers. For example,

a farmer may purchase the neighbouring farm as the two farms together can
be farmed more effectively (i.e. at a lower cost per unit). Or a company (A)
purchases the shares of another company (B) with the purpose of eventually
taking over that company.

The fifth investment objective is to obtain control over a source of raw

materials or over a distribution channel. For example, a farmer purchases the
neighbouring farm primarily to obtain access to a river (water) flowing over the
farm. Or a manufacturer of shoes purchases a number of retail shoe outlets
so that his shoes can be sold exclusively by these stores.

1.3 TERMINOLOGY

The field of investments has a number of unique terms which a person must
take note of if he/she wishes to be able to read and converse on investment
matters. The various concepts are listed in the order of the context in which
they are relevant.

1.3.1 FINANCIAL INSTRUMENTS AND FINANCIAL SECURITIES

Financial instruments are the collective term used to describe all assets or
units of capital of any kind that are tradeable. The International Accounting
Standards define financial instruments as "any contract that gives rise to a
financial asset of one entity and a financial liability or equity instrument of
another entity." Financial instruments can be real or virtual documents that
represent a legal agreement between the issuer thereof and counterparty,
involving any kind of monetary value. The emphasis is placed on the
tradability of the value paper, i.e. the ability to transfer ownership of the asset
from one person to another. For instance, shares can be sold to another
person, and that person then becomes the new owner of the shares.

A financial security is a type of financial instrument which can be traded on a

securities exchange. A security is a financial instrument that represents an
investment as an owner in a corporation (stock), a creditor relationship with a
corporation or governmental body (bond), or the rights to ownership as
represented by an option. The company or entity that issues the security is
known as the issuer. In the case of securities, the emphasis is placed on the
guarantee function of financial and other assets, i.e. the ability of value

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papers to serve as guarantee/security when applying for loans, overdraft

facilities, etc.

Securities under equity-based financial instruments include shares, whereas

securities under debt-based financial instruments include bonds. Normally all
stocks and bonds can serve as security, as well as non-tradeable paper such
as life insurance policies and even assets such as property.

1.3.1.1 Shares

A share refers to the small ‘units of ownership’ that the capital of a company
consists of. The need for share companies arose when sole proprietorships
and partnerships could not obtain sufficient capital to fund large activities any
more. The Dutch-East-Indian Company which undertook the sea voyages
around the Cape to the Far East is an early example of a share company. A
number of businessmen bought shares in the company and became co-
owners of the company. As a result, large amounts of capital were obtained
which were used to finance the voyages. If successful, the profits were
distributed amongst the shareholders according to the number of shares that
they held. If unsuccessful, the shares would become worthless and the
shareholders would lose the amount they invested in the company.

In the past companies issued share certificates to the purchasers of shares.

A share certificate is a document issued by a company to its shareholders to
serve as proof of the number of shares owned by the purchaser (shareholder).
Share certificates used to be paper documents and needed to comply with a
number of prerequisites, but due to today’s electronic nature of systems and
data and the process of dematerialisation, share certificates quickly started to
disappear. Today, shares are purchased electronically and the shares are
held in an electronic account.

1.3.1.2 Bonds and gilts

Bonds are tradeable debt instruments that can be issued by corporations

(also referred to as debentures) or by governments or quasi-government
institutions (also referred to as gilts). The most important characteristics of
bonds are that they are loans that must be repaid on a future date and that a
fixed interest (remuneration) must be paid periodically to the owner of the
bond. The market price of the bonds tends to fluctuate around the issuing
price (par value) of the bonds as market interest rates increase and decrease.
On the repayment date (maturity date) the original loan plus that year’s
interest will be repaid, thus the market price will be equal to the par value.
Most of the bonds therefore offer little opportunity for realising capital gains,
but are included in portfolios because they provide a steady, fixed income to
investors.

As mentioned in the description of bonds, gilts are debt instruments issued by

state and semi-state institutions. The best known examples include the RSA’s
and Eskom gilts.

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1.3.2 SECURITIES EXCHANGE

A securities exchange is a company that creates the opportunity for potential

buyers and sellers of a security to come together for trading.

The Johannesburg Stock Exchange (JSE) initially only provided for the listing
and trading of shares, but has since evolved to offer the trading of multiple
types of securities.

1.3.3 STRATE AND DEMATERIALISATION

The JSE provides the platform for the buying and selling of securities through
the intervention of a stockbroker. A stockbroker is a regulated professional
individual, who buys and sells stocks and other securities for both individual
and institutional clients through a securities exchange or over the counter in
return for a fee or commission. When an investor buys or sells shares via a
licensed stockbroker, he/she strikes a deal with another investor via his/her
stockbroker. After the deal is struck, the ownership of the security must be
transferred and the payment for the purchase must be effected.

This function is performed by Strate (Pty) Ltd (South Africa’s Central

Securities Depository) with the help of specific organisations that have been
given the authority to act as Central Securities Depository Participants
(CSDP’s).

A Central Securities Depository (CSD) is an organisation tasked with

keeping the records of ownership for financial instruments such as shares.
These records are safely kept in electronic form and this allows for the daily
transfer of ownership from seller to buyer to take place easily and efficiently.

Strate (Pty) Ltd also serves as an electronic settlement system which is much
more efficient and safer than the paper based system that was employed
previously. The latter system was reliant on the manual exchange of paper
share certificates, and was prone to many administrative burdens, fraudulent
certificates, theft and long settlement delays.

To implement the electronic settlement, system they started to convert share

certificates to electronic records in 2001. This was done through the
submission of share certificates to a Central Securities Depository Participant
(CSDP) or JSE member firm for conversion into an electronic record. This
process is referred to as “dematerialisation”.

Dematerialisation is simply a technical term referring to the process whereby

paper share certificates are replaced with electronic records of ownership.
Investors hand in their certificates which will then be sent to the relevant
transfer secretary for validation. Once the authenticity of the certificates has
been verified, the actual conversion process begins. This implies that share
certificates in a tangible form will cease to exist once it is handed in for
conversion. To date, over 98% of the value in the market has been
dematerialised through the stockbroker and / or CSD Participant network.

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CSDP’s are the only market players who can liaise directly with Strate (Pty)
Ltd. Most of the current CSDP’s are banks. In order to qualify for this status,
they had to fulfil the entry criteria set out by Strate and be approved by the
Financial Services Conduct Authority (FSCA).

1.3.4 MONEY MARKET AND CAPITAL MARKET

The money market is the total market of all short-term funds traded, i.e.
securities with a maturity of one year or less. This includes all short-term
investments such as savings accounts, day deposits and cheque accounts as
well as all short-term loans such as bank overdrafts and instalment credit. The
surplus or shortfall of short-term funds will influence the money market interest
rates. The capital market is the market where long-term securities are bought
and sold. Long-term investments such as fixed deposits and participation
bonds and long-term loans such as mortgages and debentures will determine
the capital market interest rates.

1.3.5 PRIMARY MARKET

A primary market is the market where listed companies and governments

sell securities for the first time. When a company issues new shares, the initial
value at which the shares are issued is referred to as the nominal value or par
value of the shares and this is the value that is reflected in the Statement of
financial position of a company. In South Africa, however, the Companies Act
No.71 of 2008 prescribes that all ordinary shares issued after 1 May 2011, no
longer have a par value. These shares are referred to as non-par value
shares and the value per share is referred to as the average issue price of
the shares.

If the company requires additional capital at a later stage, more shares can be
issued/sold to the existing shareholders and public. This is defined as a rights
issue and also takes place on the primary market. The new shares are
normally issued at a price lower than the market price (the issue price).
(Rights issues are discussed in more detail under the section of corporate
actions).

If new shares are issued by a company, a prospectus has to be issued by

the issuing company. A prospectus is a document which is issued to provide
the current as well as potential shareholders of a company with the necessary
information concerning a new issue of shares, as well as inviting interested
parties to purchase the new shares. It is therefore a source of information
concerning the new issue of shares, as well as an invitation to purchase the
shares. All companies (private and public) would therefore publish a
prospectus when new shares are issued.

1.3.6 SECONDARY MARKET

Once the new shares have been issued and bought by investors, these
investors can decide whether they want to keep them or trade them. The
trading of these shares takes place in the secondary market. The shares can

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be traded at a value higher or lower than its original issue price – the value will
be determined by the success of the company, the quality of decisions made
by management and the future prospects of the company. The value at which
the shares are traded on the secondary market, is defined as the market
price, and this market price is determined by the supply of and demand for
the specific company’s shares. If the company is listed on the JSE, the shares
can easily be traded via stockbrokers.

1.3.7 SHARE PRICE

Share price refers to the price at which a share is traded in the secondary
market, i.e. the market price of the share. If you consider the prices published
online by financial websites like Moneyweb and Fin24, you would note that a
minimum of three prices are generally provided. The Bid to buy price (or
Buyers Price), which represents the highest price that buyers are prepared to
pay for a share. The Offer to sell price (or Sellers Price), represents the
lowest price at which sellers are prepared to sell their shares. The Market
Price (the last traded price) is also provided, i.e. the price at which the last
transaction took place.

It is possible to identify price trends by considering these three values. For

instance, the prices 620(Bid); 630(Offer); 610(Last) indicate that the last
transaction took place at 610 cent, buyers are prepared to pay 620 cent per
share, and sellers require at least 630 cent. It would therefore appear as if the
price is under upward pressure, and the next transaction will most probably
take place at a price above 610 cent.

The market price and movements of the previous day are also published in
certain newspapers. The data usually reflects the closing price of the previous
day, the price movement for the day, the highest and lowest prices for the day
as well as the volume traded.

1.3.8 BLUE CHIPS

Blue chips are the ordinary shares of companies with an elite investment
status. These are normally companies that have built up a good reputation
over the long term by maintaining a stable and sound profit and dividend
history as well as providing healthy growth prospects.

1.3.9 PORTFOLIO AND DIVERSIFICATION

A portfolio refers to the composition and totality of a person’s investments.

An investment portfolio could consist of shares, bonds, property, options, etc.

Diversification is based on the principle of “not placing all your eggs in one
basket”. A risk-averse investor will purchase the shares of various companies
and place them in his share portfolio. Should one of the companies fail, then
the investor only suffers a loss on that company’s shares whilst all the other
shares probably increase in value. By purchasing the shares of companies in

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different industries (sectors), the investor can protect himself even further
against the investment risks.

A sensible investor will further diversify his investment portfolio by investing in

different investment instruments such as shares, bonds, property, derivatives,
crypto assets, and so forth. The greater the spread of the portfolio over
different investment instruments, the lower the risk for the investor.

1.3.10 RISK

An investor views risk as the possibility that the actual return that he realises
on an investment could be lower than the return he expected to realise. The
various types of risks will be discussed in Component 6.

1.3.11 INSTITUTIONAL INVESTORS

These are enterprises with large amounts of capital at their disposal with
which they mainly purchase shares and other investments. Unit trusts,
insurance companies and pension funds are all examples of institutional
investors.

1.3.12 UNIT TRUST

The basic function of a unit trust is to collect the small amounts of savings of
individuals and enterprises and then use the large collected amount (capital)
to purchase and manage a diversified portfolio of shares and other financial
instruments on behalf of the small investors. Individuals who want to invest
small monthly amounts (R50 or R500) cannot purchase a variety of the top
companies' shares (blue chips). It is therefore better to combine their money
with those of thousands of small investors and then collectively purchase a
good distribution (diversified portfolio) of top quality shares. This is exactly
what the unit trust does. The trust receives interest and dividends from the
shares and cash that they possess and after deducting their administration
costs, they pay out interest and dividends to their shareholders (unit holders).
Furthermore, the value of their shares (units) will increase or decrease as the
prices of the shares owned by the trust, increase or decrease.

A further advantage of unit trusts is that they employ specialists who can
make sensible purchases and sales of shares on behalf of their investors. A
large degree of specialisation exists amongst the unit trusts. One unit trust
can invest the greater portion of its funds in industrial companies, whereas
another might focus on resources or invest in overseas companies.

1.3.13 LISTING

Listing is the right that a company obtains to trade its shares on a stock
exchange after certain prerequisites are met. The company is listed in a
certain sector according to its primary activities (core business). There are
numerous requirements that a company must comply with in order to be listed
on a stock exchange (see Component 2). If a company does comply with all

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the requirements for listing on a stock exchange, a pre-listing statement

must first be issued by the company. A pre-listing statement is primarily a
source of information about the proposed listing, and not an invitation to buy
additional shares (as in the case of a prospectus, although an offer to
purchase additional shares can accompany it). Since only public companies
are allowed to be listed, a pre-listing statement will only be issued in the case
of a public company.

A company’s shares can be listed on more than one stock exchange

simultaneously; e.g., Old Mutual is listed on both the London Stock Exchange
(LSE) and Johannesburg Stock Exchange (JSE). This could provide
opportunities for arbitrage transactions.

1.3.14 ARBITRAGE

If a product is traded on two or more markets, it is possible that short-term

price differences can develop between the different markets. Arbitrage is the
process of buying the product on the cheaper market and then selling it on the
more expensive market. The person (speculator) makes a profit from the price
difference.

Let us investigate the share price of Old Mutual PLC as an example. The
company is listed on both the JSE and LSE. Assume that, due to market
conditions in South Africa the share is currently trading at 3300c (cents) per
share on the JSE. On the LSE, the same share is trading at 220 GBp (pence).
The Rand / Pound Sterling exchange rate is R17 for £1. A speculator can
generate a profit if he buys the shares at the cheaper price on the one
exchange and then sells them at the higher price on the other exchange. In
this scenario, he will need to buy shares at 3300 cents per share on the JSE
and sell those shares at 3740 cents (220GBp x 17) on the LSE. He will make
a profit of 440 cents per share less his transaction costs. As this is very
lucrative, more speculators will see this opportunity and do the same. Due to
their actions, the demand for Old Mutual shares will increase on the JSE,
therefore increasing the market price. At the same time, the supply on the
LSE will increase as more shares are sold there, and therefore the market
price will drop on the LSE. Due to the arbitrage transactions, the market price
on the JSE and LSE will once again more or less reach equilibrium.

1.3.15 BULL MARKET VS. BEAR MARKET

A bull market is a period of continuous price increases over the long-term.

During this period, there exists strong buying pressure (demand) and the
prices of most shares will increase. In contrast with this, a bear market is a
period of mainly price decreases over the long-term. (A more complete
discussion of the bull and bear market is provided in Component 4 on
Technical Analysis).

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1.3.16 BULLS, BEARS AND STAGS

A bull investor is a person that purchases shares during a bull market with the
intention of keeping them for a reasonably long period. As the stock exchange
is in a long-term period of price increases, the person will purchase shares so
that he can sell them after a couple of years at a capital profit. The bull runs
the risk that the specific company’s share price might drop, leading to a loss.

The bull speculator is also a person that purchases shares during a bull
market. His motive, however, is to achieve a capital gain (speculative profit) in
the short-term and most of the time the speculator does not have the available
funds to pay for the purchase. The shares must then be sold within a very
short period of time (a few days) so that he can obtain the money to pay for
the purchase.

The bear speculator is active during a bear market. His modus operandi is to
sell shares that he does not possess, hoping that the price will drop, so that
he can, in order to deliver the shares to the person to whom he sold them,
purchase the required shares at a lower price. Assume that Peter sold 1 000
shares (that he does not possess) of company X to John at R5 per share.
Share prices are dropping and after a few days Peter purchases the required
1 000 shares from Garth at R4 per share. Peter delivers the 1 000 shares that
he will receive from Garth, to John (as he originally sold the shares to John).
In the process Peter realises a profit of R1 000 (R5 000 – R4 000), expenses
excluded, in a period that share prices are dropping. The risk that Peter runs
is that the price of the shares might start rising after he has sold them. He will
then have to purchase the required 1 000 shares at the higher price as he is
obligated to deliver the shares to John. As the bear transaction is very risky, a
number of prerequisites are set by the JSE in order to conclude these
transactions.

The stag is a speculator that endeavours to make a quick profit out of new
listings as well as during a rights issue. When the shares of a company are
listed on the stock market for the first time, the market price tends to increase
due to various factors such as the greater marketability, prominence and
status as well as the greater pool of potential buyers. The stag will therefore
try to obtain the shares of an unlisted company just before it is listed and then
sell them at a profit immediately after listing. Likewise, the issue price of
shares offered during a rights issue is normally lower than the present market
price. The stag will try to obtain the shares offered in the rights issue and then
sell these shares at a profit the moment they are listed. The risk does,
however, exist that share prices on the stock market could drop, leading to a
loss.

1.3.17 FUNDAMENTAL AND TECHNICAL ANALYSIS

During fundamental analysis the value of a company and its shares are
determined. With the aid of various ratios aspects such as liquidity, solvency,
rate of return, etc. is determined and this helps the investor to distinguish
which companies are potentially sound investments and which to avoid.

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On the other hand, technical analysis is more concerned with the correct
timing. The economy, and all markets within it, moves in different cycles of
upswings and declines. The investor wishes to purchase an investment
instrument as the price starts to rise and then to sell it just before the price
starts declining. Technical analysis studies all market information such as
prices, volumes, etc. and this aids the investor with the timing of his
investment. Thus, whereas fundamental analysis concentrates more on what
to purchase, technical analysis is more helpful with when to purchase.

1.3.18 DIGITAL ASSETS AND CRYPTOCURRENCIES

In recent years, digital assets and specifically cryptocurrencies have become

quite popular as an investment option and some investors have sought to
include these in their investment portfolios as a possible hedge against
adverse movements in the financial markets.

Digital assets have been around for some time and would generally constitute
anything that is created and stored digitally, is identifiable and discoverable,
and has or provides value. Data, images, video, written content, and more
have long been considered digital assets with ownership rights.

With the introduction of blockchain technology in 2009, digital assets were

redefined and anything in digital form became something that could be used
to create value by means of tokenisation on a blockchain. A blockchain is a
type of shared database that differs from a typical database in the way it
stores information; blockchains store data in blocks linked together via
cryptography. Different types of information can be stored on a blockchain, but
the most common use for transactions has been as a ledger. Tokenisation is
the process of creating a digital representation of a real thing, i.e. the right to
ownership of a fixed property can, for instance, be subdivided into
cryptographic tokens enabling investors to acquire a portion of the ownership
of the asset. Newer digital assets, based on the blockchain, include non-
fungible tokens (NFT’s), cryptocurrencies, tokenised assets and Central Bank
Digital Currencies (CBDC’s).

Cryptocurrency is a medium of exchange, created and stored electronically on

the blockchain, using cryptographic techniques to verify the transfer of funds.
Cryptocurrencies are therefore not official currencies like the US dollar or
South African Rand, but joined the list of digital assets because people placed
a value on them and were able to transact with them. The sole purpose of the
Bitcoin blockchain for instance, is to effect secure peer-to-peer payments
without the use of a middleman (e.g. banks) whereas the Ethereum
blockchain has much more coding functionality and enables the creation of
smart contracts. Smart contracts inter alia allow participants to transact
without a trusted central authority.

Bitcoin was the first and is the most well-known cryptocurrency today. By the
year 2024, more than 23 000 cryptocurrencies are available, of which the top
five in terms of market capitalisation include: Bitcoin with a market share of

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53.38%, followed by Ethereum (17.78%), Tether USDt (5.29%), BNB

(3.65%) and Solana (2.89%).

In October 2022, the FSCA officially declared crypto assets as a financial

product in terms of the Financial Advisory and Intermediary Services Act
(FAIS). This means that any individual or business that provides financial
advice or intermediary services with respect to crypto assets – what is
typically understood to be a “broker” or “advisor” - will have to register as a
Financial Service Provider (FSP).

The price of Bitcoin is currently still quite volatile at times and is not
necessarily subject to the same market forces and trends that determine the
market price of equities. Although Bitcoin or any other cryptocurrency (also
known as Altcoins) can be quite risky to invest in, less risk averse investors
might include it in their portfolio for the higher return it might generate.

1.3.19 SAVINGS, FINANCIAL AND ECONOMIC INVESTMENT

Direct

Indirect

FINANCIAL ECONOMIC
SAVINGS
INVESTMENT INVESTMENT

Savings can be described as that portion of income that is not spent. Most
adults in a country have an income, be it a salary, pension, investment income
or a grant of one or other type. If an individual does not spend all his/her
income within a certain time period, the unused portion will be his/her savings
contribution. The individual can decide whether this saving will be stockpiled,
for example by placing it in a container under the bed, or whether it will be
placed in circulation in the economy. Similarly, companies and enterprises in
the private sector will save by not distributing all of their profit after taxation.
The undistributed (retained) earnings are their saving. The government can
also participate in the saving drive by spending less than what he receives,
i.e. by having a surplus on his budget.

The ideal situation is that all savings should be utilised to stimulate economic
activity. This implies that new machinery and equipment, land and buildings,
vehicles, inventory, etc. should be purchased with the money. This is known
as the economic investment of the money. Economic investment refers to
the use of the purchasing power of capital to obtain assets to be used in the
productive process. Economic investments are made in both the private and
public sector.

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The question arises: How do the savings reach the parties who need capital
for economic investment purposes? This can happen directly, for example, a
person decides to start his own business with his savings, or a company
acquires new equipment with its retained earnings. However, in many cases
the transition will take place indirectly in that the savings will reach the
investors via the financial intermediaries. The process through which the
purchasing power of capital reaches the third parties directly or indirectly via
the financial intermediaries is known as financial investment.

The financial intermediaries are subdivided into two groups according to the
period that the funds are available. On the money market funds are available
and utilised over the short term. Savings accounts, cheque accounts, options,
bank overdrafts are typical money market instruments. On the capital market,
funds are available and utilised over the long term. Fixed deposits, shares,
debentures and mortgages are typical capital market instruments.

The investors who place their funds at the disposal of the third parties for
economic investment expect a return on their money for the risk that they
undertake. This return could be in the form of interest and/or dividends.

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