RISKS IN INVESTMENTS

Evaluating Various Risks in Investments

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Evaluating Various Risks in Investments

Introduction

There is no investment in the world which is totally risk-free. All investments, be those economically managed or financially, contain risks. Most of the investments contain very high and considerable risks. The goal of the investor is to balance his or her expected returns with the magnitude of risk that they are assuming. In other words, any sane investor expects a rate of return which is at least commensurate with the level of risk that they are assuming. This shows the risk-averse nature of all or most of the investors.

Most investments contain various types of risks including the capital risk, income risk, and the liquidity risk. The capital risk is the potential loss of investment capital (or the principal amount) due to the possible bankruptcy or delinquency of the investment provider. In addition, the investor is also prone to income risk which mostly arises in interest income earned due to the changes in going interest rates or in the level of the interest rates (Hannah, 2011). Finally, the investor may also be exposed to the liquidity risk if he or she is unable to easily liquidate their investments in the market due to lack of the marketability of the investment (Devadason, n.d.). This risk might also arise if the investment provider is unable to terminate the investment at the investor’s demand (Drehmann and Nikolaou, 2009).

Evaluating various risks in given investments

Investment risks in various investments

We can evaluate the various investment risks inherent in different given investment options. The first investment available is the Saver Safe+ account. This investment has very high capital risk such that there could be a total loss of capital. This shows 100% capital risk. This capital risk arises from the possible bankruptcy or delinquency of the bank. However, since the bank offers variable rate of return that is obviously pegged to the going interest rates, therefore, it represents no interest rate risk or income risk (as the entire income is interest in this investment). Finally, the investment has negligible liquidity risk as these accounts are readily redeemable.

The second available investment is Indexed Saver account. This investment also has very high capital risk equal to 100% of the invested capital. This could happen due to bankruptcy or delinquency of the bank. This investment does not have any income risk as the bonds are index-linked. Finally, the investment has some liquidity risk as the bonds might not have too much marketability or might incur capital losses associated with liquidation.

The third investment is in the shares of the BigBank. This investment has total capital risk up to 100% of the invested capital, even though there will be capital appreciation or depreciation. Further, this investment has income risk as the income will lose value if the interest rates rise. This will happen as the returns (from capital gains or dividends) are not linked to the interest rates. Finally, there could be some liquidity risk as the shares ...