Role of Financial Institutions



Introduction

The fundamental principle of investment is that the expected return from any type of investments is directly attached to the risk associated with the investment. This fact is widely accepted by all investors, financial institutions and banks around the globe. It has been seen that the general investors used to give their money to financial institution for the sake of return. This report will focus on investment decision of financial institution and will analyze that whether the financial institution should invest in junk bonds or not. There are different types of investors such as risk aversed or risk oriented. In the same fashion, there are different types of investment options where few options posses high degree of risk and other are less risky. It is in the jurisdiction of investors and financial institution that which investments option should be availed. The report will provide justification for not investing in the junk bonds because these investments are so risky and often destroy the value of investors. The report will also provide reasons behind not investing in the junk bonds and highlight the benefits of investing in less risky investments options.

Discussion

Avoid Junk Bonds

The primary purpose of any financial institution is to maximize the value of investors by investing in different investment options. The investors who do not posses expert knowledge of financial instruments prefer to invest their money with the help financial institutions. These investors actually show their confidence in the financial institutions that that these financial institutions will invest their money with due care and will make them earn good rate of return (Yago et.al, pp. 60).

Therefore, investing in the junk bonds is not a good idea because these junk bonds carry unnecessary amount of risk which has the potential to destroy the value of investors. So it can be said that if financial institution invest in junk bonds than they will show a less caring attitude of investors money. There are many different tools which assessed the amount of risk attached in any given investment and also help the managers of financial institution to avail risky investment by diversifying investment. However, these tools can never actually decline the amount of risk attached in any given investment. These tools just diversify the amount of risk of one risky investment among a pool of investments. It can be inferred that these tools actually destroy the return of other investments as they distribute the risk among pool of investments (Perry et.al, pp. 40).

It is a fact that the main reason which provides impetus to investor to invest in financial institution is the higher level of trust. It is very important for the financial institution to maintain the level of trust because if the trust of investors has been broken once then there is no chance that the investor will again trust the financial institutions. The option of investing in junk bonds is like taking excessive risk and putting investor value at stake which is highly not recommended. The financial ...