Explain the difference between direct investment and portfolio investment

One of the most important distinctions between portfolio and direct investment to have emerged from this young era of globalization is that portfolio investment can be much more volatile. Changes in the investment conditions in a country or region can lead to dramatic swings in portfolio investment. For a country on the rise, FPI can bring about rapid development, helping an emerging economy move quickly to take advantage of economic opportunity, creating many new jobs and significant wealth. However, when a country’s economic situation takes a downturn¯sometimes just by failing to meet the expectations of international investors¯the large flow of money into a country can turn into a stampede away from it.

By contrast, because FDI implies a controlling stake in a business, and often connotes ownership of physical assets such as equipment, buildings and real estate, FDI is more difficult to pull out or sell off. Consequently, direct investors may be more committed to managing their international investments, and less likely to pull out at the first sign of trouble.

This volatility has effects beyond the specific industries in which foreign investments have been made. Because capital flows can also affect the exchange rate of a nation’s currency, a quick withdrawal of investment can lead to rapid decline in the purchasing power of a currency. Such quick withdrawals can produce widespread economic crises.

This was partly the case in the Asian economic crisis that began in 1997. Although the economic turmoil began as a result of some broader shifts in international economic policy and some serious problems within the banking and financial sectors of the affected East Asian nations, the capital flight that ensued—some compared it to the great financial panics which took place in the United States during the 19th century— significantly exacerbated the crisis.

Analyse the factors that influence the investment levels

There are no hard and fast rules that determine patterns and levels of investment made by either institutional investors or individuals. However, there are a few common factors and boundaries that will at least influence investors’ decisions on how much to invest. Decisions on how these factors affect investment strategies vary from investor to investor, but in general they must be considered at some level.

Available Resources

The first and most important factor has to do with the available assets of the person or institution making the investment. Obviously, investment will be bound by how much money is available, but these considerations are a bit more nuanced. For example, a company with a good deal of liquid assets wouldn't necessarily invest even a sizable chunk of them if they had a lot of other commitments to meet, such as payroll and debt. By the same token, individual investors would be ill-advised to invest money that they normally spend on bills. It all depends on the priority that the investment takes, how it interacts with other monetary priorities and what the expected result of the investment will be.

Market Prediction

The next factor that will help to determine the level of investment is predictions on results of the investment based on the available information. Of course, no investment is foolproof enough to put all of your money into, and by the same token, even the riskiest investment might be worth throwing a little bit of extra cash at. Even though there is no guaranteed way to predict the market, awareness about possible outcomes will determine what a reasonable level of investment is. For example, it would be much more tolerable to put a large sum of money into high-rated government bonds than into some unknown start-up company. Different levels of investment are appropriate to each situation.

Type of Assets

The type of asset being invested in is another important factor depending on the individual or organization making the investment. For example, some types of assets, such as financial derivatives, can be highly risky and don't really have any value unless they are cashed in at the right time. On the other hand, certain investments can be much more tangible and can go beyond the simple goal of earning a profit. A good example is real estate. Real estate is clearly not a foolproof investment. However, as a tangible asset in a growing marketplace, real estate is inherently valuable, and can be particularly so if it can help investors expand their operations or accomplish goals.

Tolerable Risk

The bottom line for any investment, to determine whether it is acceptable or not, is assessing the level of tolerable risk. Common sense dictates that no individual or institution should ever invest more than they are willing to lose, since, unlikely as it may be, losing the whole investment is always a possibility. Risk should be taken very seriously and assessed painstakingly. In some situations, there is a risk factor that goes beyond the loss of the initial investment. For example, certain investments might require the investor to spend money on maintenance and upkeep, or might potentially embroil the investor in legal trouble. These factors should always be considered.