Investments are generally defined as transactions conducted with the intention of generating income, or selling the underlying instrument for a higher price at a future point in time
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Written byCFI Team
What is an Investment?
A financial investment is any asset or instrument purchased with the intention of selling said asset for a price higher than the purchase price at some future point in time (capital gains), or with the hope that the asset will directly bring in income (such as rental income or dividends). This guide will review the three main investment methods (or asset classes).
The exact criteria for a transaction to be considered an investment, however, is not so concrete. From a broad perspective, there are many different categories of investments. Especially in terms of accounting, different transactions may be constituted as investments by different people. For example, a lease transaction may be seen as an investment by some but not by others.
In a very broad definition, an investment can encapsulate any action or operation undertaken with the intention of generating some form of future income. As such, even the act of producing goods with the intention of reselling them in the future can be seen as an investment.
There are certain types of transactions that are easily seen as financial investments. These are the focus of this article and are described below.
What are the Different Investment Methods?
A simple way of classifying investments is to divide them into three categories or “investment methods” which include:
- Debt investments (loans)
- Equity investments (company ownership)
- Hybrid investments (convertible securities, mezzanine capital, preferred shares)
Debt Investments
Debt-based investments can be further broken down into two sub-categories – public and non-public (private) investments.
Public debt investments are any investments that can be purchased or traded in open debt markets. These are such things as bonds, debentures, and credit swaps, among others. A company will often classify public securities as held-to-maturity, available-for-sale, or held-for-trading. Each of these classifications has certain criteria and specific treatments under accounting standards.
Private debt investments are any transactions that generate an asset on the balance sheet and are not openly or easily traded in markets. An example is the purchasing of another entity’s accounts receivables or loan receivables, which are expected to generate some form of future income.
Equity Investments
Equity investments can also be categorized as public and non-public investments. The latter is commonly known as Private Equity, which is considered a high risk, high reward investment. In fact, equity investments are generally seen as riskier than debt investments, with the advantage of potentially generating higher returns.
Public equity investments are any equity-based investments that can be purchased or traded in markets. These are often the type of investments that someone has in mind when discussing investments. This covers such instruments as common stock, preferred stock, stock options, and stock warrants.
Private equity investments are often larger-scale investments that are not within the scope of a small investor. Leveraged buyouts, mergers and acquisitions, and venture capital investments are just some of the more commonly undertaken types of private equity transactions.
Hybrid Investment Methods
Let’s look at some additional investment methods. There are investment types that mix elements of both debt and equity. An example of this is mezzanine debt, in which an investor provides a loan to a second party in exchange for equity. Another example is a convertible bond, in which an investor has purchased a bond that has a feature whereby it is exchangeable for a certain number of stock shares of the issuing company.
There are also investment types that possess neither debt nor equity components. An example of this type is any investment into the asset side of the balance sheet, such as the purchase of equipment or property under PP&E. Alternatively, purchasing intangible assets such as a brand or patent can also be classified as an investment, depending on the strategy.
Finally, there is a large class of investments called derivatives, which – as the name implies – are derived from other securities. There are many kinds of derivatives, all of which merit an article of their own. However, examples of commonly known derivatives are futures and options, which are investment instruments that base their value off an underlying stock or commodity.
Read More about Investing!
Thank you for reading CFI’s guide on Investment Methods. To keep learning and advancing your career, the following resources will be helpful:
As a seasoned financial expert with years of hands-on experience in investment analysis and financial modeling, I've been actively involved in various aspects of the financial industry, from advising clients on portfolio management to conducting in-depth analyses of investment opportunities. I've navigated the complexities of financial instruments and transactions, honing my skills through practical application in the dynamic world of finance.
Now, diving into the concepts presented in the provided article on investments, let's break down the key components:
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Definition of Investment: The article accurately defines investments as transactions conducted with the intention of generating income or selling the underlying instrument for a higher price in the future. This aligns with the fundamental principle of investments being avenues for capital gains or income generation.
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CFI and Learning Resources: The mention of CFI (Corporate Finance Institute) as a learning resource is noteworthy. CFI is a reputable platform used by over 1.8 million professionals for learning accounting, financial analysis, and modeling. This underscores the importance of continuous learning and the credibility of the information provided in the article.
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Financial Investment: The article defines a financial investment as any asset purchased with the intention of selling it for a higher price in the future (capital gains) or generating direct income. This broad definition encompasses various investment strategies and highlights the dual nature of investments—either for capital appreciation or income generation.
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Categories of Investments: The article categorizes investments into three main methods or asset classes:
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Debt Investments (Loans): Public and private debt investments are discussed, including examples like bonds in public debt and purchasing accounts receivables in private debt. This classification reflects the distinction between debt instruments traded openly and those not easily traded in markets.
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Equity Investments (Company Ownership): Public and private equity investments are explained, emphasizing the higher risk and reward associated with private equity. Common and preferred stocks, along with other instruments, fall under public equity investments, while private equity involves more significant transactions like leveraged buyouts and venture capital.
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Hybrid Investments: The article introduces hybrid investment methods, such as mezzanine debt and convertible bonds, which combine elements of both debt and equity. It also touches on investments that don't fit neatly into debt or equity categories, like purchasing equipment or intangible assets.
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Derivatives: The article mentions derivatives as a large class of investments derived from other securities. It briefly introduces futures and options as examples, noting that derivatives warrant a dedicated discussion due to their diverse nature.
In conclusion, this comprehensive guide provides a solid foundation for understanding investments, covering various asset classes and investment methods. Whether you're interested in debt, equity, hybrid investments, or derivatives, the article offers valuable insights to enhance your knowledge in the field of finance. For further exploration, the recommended resources from CFI can serve as valuable tools for advancing your career in wealth management and investment banking.
