Understanding Investment Strategies and Financial Concepts
Profitability and Investment Decisions
Profitability is the relationship between profit generated by business activity and the investment made (company assets). Investments should be projected into the future.
Criteria for Investment Decisions
The aim is to optimize the use of economic resources. Criteria are parameters or guidelines that play an important role in decision-making. These include:
- Optimizing the use of economic resources.
- Maximizing profit in present value.
- Choosing financing options that maximize earnings per share or minimize costs (measurable monetarily).
- Aligning investment decisions with company objectives.
Benefit is the result of an activity and involves quantitative and qualitative analysis.
Return is the result of an investment, measured as: Yield = VF/VI – 1 (Result in percentage %)
Profit is equal to revenues minus costs: Profit = U = Revenues – Costs
Gain is the net profit.
Performance is the gain compared. Profitable investments are essential.
Investment Objectives and Company Goals
Investment decisions should align with company objectives, which may include:
- Survival during crises.
- Increased market share.
- Maximizing asset value.
- Expanding employment (focusing on social returns).
Ensuring Success
- Increasing sales.
- Acquiring more assets.
- Enhancing prestige (quality, service, value-added).
- Building capital and productivity.
Key Financial Concepts
Productivity and Income
Productivity: Performance is derived from capital productivity.
Marginal Income: Income earned from increased sales over the previous period. Increased production contributes to marginal revenue.
Opportunity Cost: Measures decision alternatives based on the sacrifice of choosing one option over another, considering the potential result of the unchosen alternative.
Marginal Cost: Cost incurred from producing one more unit.
Analysis and Valuation
Sensitivity Analysis: Considers scenarios where sales decrease or production costs increase.
Net Present Value (NPV): Calculated from company cash flows brought to present value, considering capitalization effects.
NPV indicates how an investment capitalizes when brought to present values.
Types of Investments
Key questions for investment budgeting:
- How much to invest?
- How to invest?
- Where to find investment resources?
Change: A concept in Financial Mathematics.
Cost efficiency leads to decreased costs and increased revenues.
Profit Maximization and Present Value
Financing decisions should maximize earnings per share or minimize costs (measurable monetarily).
Performance is a function of risk, amount, and return.
Profit maximization occurs where marginal revenues converge with marginal costs.
Investment Classification
1. Compulsory Investment: Made for risk prevention (industrial, corporate, financial, operational) or to avoid contingencies.
2. Non-Profit Investment: Applied to projects like gymnasiums, nurseries, or altruistic actions.
Investment Definition: The investment structure defines the organic composition of capital.
Discount Rate: The minimum interest rate for a project.
Break-Even Point: Indicates when the investment is recovered.
MARR: Minimum Acceptable Rate of Return.
IRR: Internal Rate of Return, indicating investment attractiveness.
NPV: Net Present Value.
Opportunity cost differentiates between investment and consumption.
Yield Components
- Interest: Principal plus the interest rate.
- Capital Gain: The difference between the investment and the final result.
Investment Approaches
Direct Investment: A resident entity in one economy (direct investor) obtains a lasting interest in an enterprise in another economy (direct investment enterprise).
Indirect Investment: Loans made abroad, also known as portfolio investment. Includes loans from international organizations to governments or public enterprises (financial assets).
Volatility: High variation in yields, measured with variance.
Variance: Establishes limits for yield fluctuations.
Seasonality: Different points used to analyze fluctuations and establish periods with varying seasonality.
Profit (ð) = Net Income ($)
Other Investment Considerations
Investments with Difficult-to-Measure Profitability: Investments in developing technical coefficients of production.
Replacement Investment: Purchasing modern equipment to reduce costs or increase production capacity.
Investing to Attack New Markets and New Products: High-risk investments requiring higher returns.
Investment Definition: Has two meanings: (1) Action and readiness, (2) Profit-seeking process with future expectations.
Stock Trader: Efficiency depends on costs.
Investment Expansion: Investments aimed at increasing company revenues and expanding facilities.
Higher risk levels require diversification in investment decisions.
Investment Strategies and Resource Allocation
Random Variables: Conventional and Unconventional Resources
Conventional: Investments with initial negative cash flows followed by positive flows.
Unconventional: Investments with alternating positive and negative cash flows after the initial investment, potentially leading to errors in IRR calculation.
Routine or Strategic Investment Tactics
Routine investments maintain the same risk level, while strategic investments involve higher risk and may focus on new products for market positioning.
Investment Strategy: A strategic investment focuses on strategic sectors.
Information: Includes income, expenditures, preferences, competition, and target market conditions.
Country Risk: Understanding market tastes and preferences helps determine risks.
Investment to Accept or Reject a New Long-Term Special Order: Investments requiring new equipment purchases to fulfill special orders while maintaining operating conditions.
Additional Investments: Reinforcements made to complement a major investment.
Hedging: Insurance against devaluation.
Mutually Exclusive Investments: Accepting one investment requires rejecting another.
Analysis of Returns: Conducted when specific performance targets are required.
Divestiture: Removal of plants, products, or departments (liquidation).
Financial Gain: Technical rebound.
Dividends, Inflation, and Market Dynamics
Dividends: Shareholder participation in profits (distributed according to input).
Remaining profit is considered net investment for the next year.
Reference currency allows comparison with other economies.
Inflation: General price increase. The rate obtained in yields after removing the inflationary effect (deflated).
(Modern Portfolio Theory) Harry Markowitz
NASDAQ: The largest stock market globally.
Financial Group: Brokerage houses, banks, insurance companies, aphorisms, factoring, leasing, and investment companies.
Interest Rate: Percentage charged as a fixed sum.
Real Interest Rate: Considers the devaluation effect of inflation.
Active Rate: Interest rate charged by banks.
Passive Rate: Interest rate banks are charged (e.g., for deposits and savings).
Moral Hazard: Probability of loan default by the borrower.
Risk Premium: Excess return required for investing in a risky asset compared to a risk-free asset (reward for taking risk).
Sectoral Risk: Risk associated with a specific industry.
Market or Systemic Risk: Risk attributed to stock market collapse and contraction of aggregate demand, leading to reduced investment and government spending.
TIIE: Interbank interest rate (equilibrium).
Bank Interest Rate Determination
Factors influencing bank interest rates:
- Amount of assets and money, measured by the bank’s rate of return or capitalization rate.
- Term: Duration for the bank to generate returns.
Stock System: Prepares companies for market entry.
INDEVAL: Responsible for investor protection.
Each portfolio is assigned a beta (β).
Beta (β): Measures returns relative to the market.
[β = 1 = Market] [β < 1 = Less than Market] [β > 1 = More than Market]
Investment: Has two meanings: (1) The act of investing, (2) Providing resources for future gain.
Investment anticipates future benefits, while saving postpones consumption.
Real and Financial Investments
Real Investment: Investment in tangible assets like property, plant, equipment, inventories, land, real estate, or an entire enterprise.
Financial Investment: Contributing resources to an organized market for future benefit.
Global and International Investments
Global Investment: Investing in securities across multiple countries, including the investor’s own country.
International Investment: Investing in securities of a single country other than the investor’s country.
Four Parameters of Investment
Performance, Liquidity and Exchanges, Time, and Risk
Performance: Benefit derived from a financial investment.
Currency: Currency in which the investor desires performance.
Time: Investment performance, typically expressed as an annual percentage.
Liquidity and Organized Markets: Instrument’s ability to be sold depends on the existence of an organized market.
Term: Varies based on the investor and market conditions. Short-term can be a day or a week, medium-term a month, and long-term can extend further.
Risk: Possibility that the expected return on an investment may not materialize. Also refers to the variation or volatility in performance.
Hierarchy of Performance and Risk Tolerance
Investors set performance goals based on their risk tolerance. Different investment categories have varying performance levels and corresponding risks. Investors must align their goals with time and liquidity considerations.
Real Rate and Country Risk
A country’s real rate reflects its risk-free rate. In Mexico, the 28-day CETES rate is often used as the risk-free rate. Higher real rates typically indicate higher country risk.
Inflation-Indexed Bonds and Risk-Return Relationship
Inflation-indexed bonds offer a guaranteed real rate over a longer term, providing more security than shorter-term real rates. Investors demand higher returns for investments with higher risk.
Debt and Equity Premiums
Term Premium: Compensation for holding a longer-term debt instrument.
Corporate Debt Premium: Higher risk of default for private sector debt compared to government debt.
Premium for Large Firms: Premium investors demand for the higher risk associated with stocks compared to debt instruments.
Premium for Midsize Businesses: Higher risk premium for stocks of medium-sized companies due to increased earnings volatility.