Chapter 9- Investments 9.1 Understanding Investments Types of Investments Companies may hold investments for many reasons: 1. to have the capital appreciate, or 2. to earn dividends, interest, and/or income. There are two basic types of investments in terms of contractual rights and obligations: debt instruments and equity instruments. They are both considered to be financial assets to the investor. Companies that invest in debt instruments of another entity are creditors of the issuing company. Debt instruments debt securities, prices are an active market, such as investments ingovernment and corporate bonds, convertible debt, and commercial paper. Debt instruments have contractual requirements regarding repayment of principal and payment of interest. Equity instruments Represent ownership interests. Ex common, preferred, or other capital stock or shares. They also include rights to acquire or dispose of ownership interestsat an price, such as warrants, rights, and call or put options. Do not have a maturity date and pay dividends (instead of interest). depending on the nature of the instrument. Rights to dividends, voting rights, and rights to residual assets upon liquidation. Types of Companies That Have Investments Motivation Returns provided by investments through interest, dividends, or capital appreciation. Provide guaranteed returns (such as term deposits), while others are riskier (such as investments in shares of other companies). Managers may invest for short-term returns or longer-term returns To have a special relationship with a supplier or customer, such as being able to access certain distribution channels or a supply of raw materials. Exercise its rights to influence or control the operations of the other company, the investee. establish a long-term operating relationship between the two entities. Examples of companies investments in financial instruments include financial institutions such as banks, pension funds, and insurance companies. Banks add value by investing other people's money and earning a return that is higher than their cost of capital. Pension plans, collect money from employers and employees invest the money The investments are labelled for the nature of the instruments, such as bonds or stocks, and sometimes they are labelled with accounting labels, such as available for sale or trading How investments are accounted for can depend on thetype of instrument, management's intent, company strategy, and the ability to reliably measure the investment's fair value.
Measurement measured initially at their fair value at acquisition.The price of a debt instrument is quoted as a percentage of its par or face value Shares that are traded on a stock exchange are usually quoted at the market price per share in dollars and cents. Investments in shares may be acquired on margin: the investor pays only part of the purchase price to acquire the shares, the rest is financed by the broker. Transaction costs (fees, commissions, or transfer taxes) can be accounted (1) to expense these amounts immediatelyusing a fair value model, the fair value of an asset is its market price (2) to add them to the cost of the assets acquiredusing a cost-based model (costs are a necessary cost of acquiring the asset) When a financial instrument ismeasured at fair value, afteracquisition changesin its fair value carrying amount are calledunrealized holding gains or losses.The change in value is unrealized because it has not been converted to cash or a claim to cash—the asset is still held by the entity. Such gains and losses are only realized when the asset is disposed of. Unrealized holding gains and losses may be separately identified from realized gains and losses on the financial statements.5
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