Global Investing vs. Financing

By M. Isi Eromosele

The term ‘investing” can be associated with different activities, but the common target in these activities is to use the money (funds) during a time period to seek the enhancement of an investor’s wealth.

Funds to be invested come from assets already owned, borrowed money and savings. By foregoing consumption today and investing their savings, investors expect to enhance their future consumption possibilities by increasing their wealth.

It is useful to make a distinction between real and financial investments. Real investments generally involve some kind of tangible asset, such as land, machinery, factories, etc. Financial investments involve contracts in paper or electronic form such as stocks, bonds, etc.

Financing

Corporate finance typically covers such issues as capital structure, short-term and long-term financing, project analysis, current asset management. Capital structure addresses the question of what type of long-term financing is the best for the company under current and forecasted market conditions; project analysis is concerned with the determining whether a project should be undertaken.

Current assets and current liabilities management addresses how to manage the day-by-day cash flows of the firm. Corporate finance is also concerned with how to allocate the profit of the firm among shareholders (through the dividend payments), the government (through tax payments) and the firm itself (through retained earnings).

But one of the most important questions for the company is financing. Modern firms raise money by issuing stocks and bonds. These securities are traded in the financial markets and the investors have possibility to buy or to sell securities issued by the companies.

Thus, investors and companies searching for financing realize their interest in the same place, in financial markets. Corporate finance area of practice involves the interaction between firms and financial markets and investments area practice involves the interaction between investors and financial markets.

The investment field also differs from the corporate finance in using the relevant methods for research and decision making. Investment problems in many cases allow for a quantitative analysis and modeling approach and the qualitative methods together with quantitative methods are more often used to analyze corporate finance problems.

The other very important difference is that investment analysis for decision making can be based on the large data sets available from the financial markets, such as stock returns, thus, the mathematical statistics methods can be used.

Corporate Finance and Investments are built upon a common set of financial principles, such as present value, the future value and the cost of capital. And very often, investment and financing analysis for decision making use the same tools but the interpretation of the results from this analysis for the investor and for the financier are different.

For example, when issuing securities and selling them in the market, a company performs valuation looking for the higher price and for the lower cost of capital, but the investor using valuation search for attractive securities with the lower price and the higher possible required rate of return on his/ her investments.

There are two types of investors:

• Individual investors
• Institutional investors

Individual investors are individuals who are investing on their own. Sometimes, individual investors are called retail investors. Institutional investors are entities such as investment companies, commercial banks, insurance companies, pension funds and other financial institutions.

In recent years the process of institutionalization of investors has accelerated.  The main reasons for this trend are that institutional investors can achieve economies of scale,

demographic pressure on social security and the changing role of banks.

Direct vs. Indirect Investing

Investors can use direct or indirect type of investing.  Direct investing is realized using financial markets and indirect investing involves financial intermediaries.

The primary difference between these two types of investing is that in applying direct investing, investors buy and sell financial assets and manage individual investment portfolio themselves.

Consequently, by investing directly through financial markets, investors take all the risk and their successful investing depends on their understanding of financial markets, its fluctuations and on their abilities to analyze and evaluate the investments as well as manage their investment portfolio.

Conversely, by using indirect type of investing, investors are buying or selling financial instruments of financial intermediaries (financial institutions) which invest large pools of funds in the financial markets and hold portfolios.

Indirect investing relieves investors from making decisions about their portfolio.

As shareholders with ownership interest in the portfolios managed by financial institutions, the investors are entitled to their share of dividends, interest and capital gains generated and pay their share of the institution’s expenses and portfolio management fee.

The risk for investors using indirect investing is related more with the credibility of chosen institution and the professionalism of their portfolio managers. In general, indirect investing is more related with the financial institutions which are primarily in the business of investing in and managing a portfolio of securities.

Investors can invest their funds by performing direct transactions, bypassing both financial institutions and financial markets. But such transactions are very risky, if a large amount of money is transferred only to one’s hands.

Companies can obtain necessary funds directly from the general public (those who have excess money to invest) by the use of the financial market, issuing and selling their securities.

Alternatively, they can obtain funds indirectly from the general public by using financial intermediaries. And the intermediaries acquire funds by allowing the general public to maintain such investments as savings accounts, Certificates of Deposit accounts and other similar vehicles.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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