MS 44 IGNOU MBA Solved Assignment -Discuss the concept of mutual funds and describe various types of schemes issued by mutual funds.

Discuss the concept of mutual funds and describe various types of schemes issued by mutual funds.

CONCEPT OF MUTUAL FUNDS :

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund:

       Every Mutual Fund is managed by a fund manager, who using his investment
         Any change in the value of the investments made into capital market instruments
in which these funds invest are called �sovereign� securities and they are assigned the
highest credit rating. These securities, usually, doesn�t carry any credit risk. However,
they carry interest rate risk due to fluctuations of their trading prices based on current
interest rate environment in the economy and a plethora of fundamental economic
conditions. The ideal investment horizon depends on the type of gilt security scheme chosen
� medium term or long term. Usually, an investment horizon of more than 1 year is
recommended.
Bond funds: These schemes invest in securities issued by central government, state
government, public sector companies and private sector companies. The objective of these
schemes is to provide a consistent high return from a portfolio of bonds comprised of the
securities described above. The ideal investment horizon is about 1 year to 2 years.
Fixed Maturity Plans: These schemes have a fixed maturity date wherein the scheme gets
matured. These schemes are closed ended in nature. They are open for a fixed duration, at
first, during which investors can subscribe for units of the scheme. After the fixed duration
gets over, the schemes close for further subscriptions. Units are allotted only to the persons
who have invested during the initial opening period. The plans have fixed maturities like 3
months, 6 months, 1 year, etc. After such a fixed period or on maturity date, units of the
investors are bought back by the mutual fund at the NAV applicable on that day. The
objective of these schemes is to provide a fixed income for a fixed period to the unit holders
from a portfolio of various types of debt instruments.
 
 Open-ended schemes
Close-ended schemes
Growth schemes
Balanced schemes
Income schemes
Money market schemes
Tax saving schemes
Index schemes
Sector-specific schemes
Exchange-traded funds
Capital protection funds
Types of Mutual Funds Scheme in India

• By Structure

• Open - Ended Schemes

• Close - Ended Schemes

• Interval Schemes

• By Investment Objective

• Growth Schemes

• Income Schemes

• Balanced Schemes

• Money Market Schemes

• Other Schemes

• Tax Saving Schemes

• Special Schemes

• Index Schemes

Sector Specfic Schemes

             When you invest in a mutual fund, your earnings are derived from two potential

sources: any appreciation in the value of your fund shares and any fund distributions. Your

total return is a combination of these two elements.

         Once you have determined your fund's total return, you can compare your returns to

the market and to mutual funds with similar investment objectives.

Mutual fund is a trust that pools money from a group of investors (sharing common

financial goals) and invest the money thus collected into asset classes that match the stated

investment objectives of the scheme. Since the stated investment objectives of a mutual

fund scheme generally forms the basis for an investor's decision to contribute money to the

pool, a mutual fund can not deviate from its stated objectives at any point of time.

management skills and necessary research works ensures much better return than what an

investor can manage on his own. The capital appreciation and other incomes earned from

these investments are passed on to the investors (also known as unit holders) in proportion

of the number of units they own.When an investor subscribes for the units of a mutual fund, he becomes part owner

of the assets of the fund in the same proportion as his contribution amount put up with the

corpus (the total amount of the fund). Mutual Fund investor is also known as a mutual fund

shareholder or a unit holder.

(such as shares, debentures etc) is reflected in the Net Asset Value (NAV) of the scheme.

NAV is defined as the market value of the Mutual Fund scheme's assets net of its liabilities.

NAV of a scheme is calculated by dividing the market value of scheme's assets by the total

number of units issued to the investors

The following are broadly the schemes offered by mutual fund companies.

Income Category

       This category of schemes invests only into debt instruments issued by government, public or private companies.

Liquid Funds: These schemes invest in short term income instruments such as certificate

of deposits, treasury bills and short-term bonds. The objective of these schemes is to

provide current income with high liquidity. The ideal investment horizon is 1 day to 1

month.

Short-Term Income Funds: These schemes invest in short-term money market

instruments and corporate bonds. The objective of these schemes is to provide a higher

current income than liquid funds but without compromising the liquidity. The ideal

investment horizon is 1 month to 3 months.

Medium-Term Income Funds: These schemes invest in medium-term treasury bills and

corporate bonds. The objective of these schemes is to provide a higher current income

than short-term income funds with reasonable liquidity. The ideal investment horizon is 3

months to 6 months.

Long-Term Income Funds: These schemes invest in medium to long term treasury bills,

dated government securities and corporate bonds. The objective of these schemes is to

provide consistent returns higher than medium term income funds with reasonable

liquidity. The ideal investment horizon is more than 6 months to 2 years.

Floating Rate Funds: These schemes invest in short-term to long-term instruments

comprising of government securities and corporate bonds. The objectives of these

schemes to provide consistent returns by investing in floating rate instruments, which are

indexed to interest rate or consumer price indexes. These schemes also provide

reasonable liquidity to the investors. The ideal investment horizon depends on the type of

floating rate scheme chosen � short term floating rate scheme, medium term floating

rate scheme, floating rate income scheme, etc.

GILT Funds: These schemes invest in securities issued by the government. The securities

These funds do not have a fixed maturity and one can invest in such funds on any working day, during business hours. Investors can buy or sell units of open-ended schemes directly from the fund house at NAV related prices.

Such funds have a fixed maturity period and are open for subscription only for a specified period. After the expiry of this period, investors can buy or sell the units on the stock exchanges where such funds are listed. Some funds also have the option of periodic repurchase, whereby investors can sell back their units to the fund at NAV related prices.

Interval schemes

Interval schemes are a combination of both open and close-ended schemes. Investors can purchase or redeem their shares from the fund house at pre-determined intervals at NAV related prices

Such funds are aimed at capital appreciation over the medium to long term. Usually, such funds invest a major portion of the portfolio in equities.

Such funds have a balanced portfolio and invest in equity and preference shares in addition to fixed income securities. The aim of such funds is to provide both income and capital appreciation over a long-term.

These schemes invest primarily in fixed income instruments issued by the government, banks, financial institutions and private companies. The main objective of income schemes is preservation of capital and to provide fixed income over the medium to long term.

Money market schemes invest in short-term debt instruments, which earn interest and have high liquidity. Though these are considered to be the safest investment option, such funds are subject to fluctuations in the rates of interest.

Such schemes are aimed at offering tax rebates to investors under specific provisions of the Income Tax Act, 1961. For instance, investors of Equity Linked Savings Schemes (ELSS) and Pension Schemes are applicable for deduction u/s 88 of the Income Tax Act, 1961.

Such funds strive to mirror the performance of specific market indices, such as the BSE SENSEX, CNX Nifty, etc which are called the base index. Investments in such funds are made in the same stocks as the base index and in similar proportion.

Such funds invest in a specific industry or sector. The investments could be in a particular industry (Banking, Pharmaceuticals, Infrastructure, etc) or a group of industries, or various segments (like ‘A’ Group shares). 

Such funds are listed and traded on the stock exchange in a similar manner as stocks. Such funds invest in a basket of stocks and aim at replicating an index (S&P CNX Nifty, BSE Sensex) or a particular industry (banking, information technology) or commodity (gold, crude oil, petroleum).

These funds are designed to safeguard the capital invested therein, by investing in suitable securities.

      Wide variety of Mutual Fund Schemes exist to cater to the needs such as financial

position, risk tolerance and return expectations etc. The table below gives an overview into

the existing types of schemes in the Industry. 

MS 44 IGNOU MBA Solved Assignment -What are Formula Plans? Critically evaluate the various formula plans.

What are Formula Plans? Critically evaluate the various formula plans.
            By establishing a specific set of rules for investors to follow, formula

investment plans try to take the emotion out of investing. A formula investment plan is a

systematic method of portfolio management. Using it, buy and sell decisions are strictly

dictated by security price movements and the changes in individual security weightings that

result within a portfolio.

          Often, formula plans divide an investor's portfolio into two

portions: speculative and conservative. The speculative portion contains aggressive, volatile

securities with the potential to earn large returns or create significant losses.

          The conservative portion holds less-volatile securities—such as government bonds—

that are expected to grow slowly but steadily.

          Investors carefully monitor the speculative portions of their portfolios. As this

component changes in value, formula investors add to, or reduce, their positions to maintain

a pre-determined level of ownership of speculative securities. This level of ownership is

simply measured in dollars in aconstant-dollar plan. In contrast to that, a constant-ratio

plan maintains a set percentage of the overall portfolio value in speculative securities.

            To ease the problem of timing and minimise the emotions involved in investing,

mechanical portfolio management techniques have been developed. These mechanical

techniques are sometimes employed to “beat the market” through timing.

Some sort of formula is used to alter exposure to the market from time to time, in the hope

of thereby taking advantage of market cycles.

However, formula plans are primarily oriented to loss-minimisation rather than return

maximisation. The chapter will examine (1) Constant- Rupee-Value, (2) Constant Ratio,

and (3) Variable-Ratio formula plans, as well as another mechanical investment plan,

Rupee-Cost Averaging.

Formula plans are efforts to make the decision on timing automatic. They consist of

predetermined rules for both buying and selling of the stock.

The selection of a formula plan and the determination of the appropriate ground rules cause

the investor to consider and outline his investment objectives and policies. Once the plan is

established, the investor is free from making emotional decisions based upon the current

attitudes of investors in the stock market.

Formula plans are not, however, a royal road to riches without any weaknesses. Firstly,

formula plans offer only modest opportunity for capital gains.

A fully managed fund will offer a greater potential gains, even though investors might not

achieve this goal. Secondly, some formula plans do not free the investor from making value

judgement as to the relative strength of the stock market.

Thirdly, a formula plan by its very nature must be inflexible, thus imposing a necessary

action by the investor. Investors may choose securities that do not move with the market.

After all the beta characteristics of securities are not that stable. Lastly, as an effort to solve

the timing problem of investing, they make no provisions for what securities should be

selected for investment.

3 different types of formula plans (Numerical Example)

Different Types of Formula Plans are given below:

1. Constant-Rupee-Value Plan:

       The constant rupee value plan specifies that the rupee value of the stock portion of the

portfolio will remain constant. Thus, as the value of the stock rises, the investor must

automatically sell some of the shares in order to keep the value of his aggressive portfolio

constant.

If the price of the stock falls, the investor must buy additional stock to keep the value of

aggressive portfolio constant.

By specifying that the aggressive portfolio will remain constant in money value, the plan

also specifies that remainder of the total fund be invested in the conservative fund. The

constant-rupee-value plan’s major advantage is its simplicity. The investor can clearly see

the amount that he needed to have invested.

However, the percentage of his total fund that this constant amount will represent in the

aggressive portfolio will remain at different levels of his stock’s values, investor must

choose predetermined action points sometimes called revaluation points, action points are

the times at which the investor will make the transfers called for to keep the constant rupee

value of the stock portfolio.

Of course, the portfolio’s value cannot be continuously the same, since this would

necessitate constant attention by the investor, innumerable action points, and excessive

transaction costs. In fact, the portfolio will have to be allowed to fluctuate to some extent

before action taken to readjust its value.

The action points may be sent according to prespecified periods of time, percentage changes

in some economic or market index, or – mostly ideally – percentage changes in the value of

the aggressive portfolio.

The timing of action points can have an important effect on the profits the investor obtains.

Action points placed dose together cause excessive costs that reduce profits.

If the action points are too far apart, however, the investor may completely miss the

opportunity to profit from fluctuations that take place between them. An example will help

to clarify the implementation of formula plans. We will use fractional shares and ignore

transaction costs to simplify the example.

Numerical Example:

To illustrate the constant rupee value plan, suppose an investor has Rs. 10,000 to invest.

The investor decides to begin the plan with balanced portions (Rs.5,000 aggressive,

Rs.5,000 defensive) and to rebalance the portfolio whenever the aggressive portion is 20 per

cent above or below Rs.5,000.

On hundred shares of a Rs.50 each stock and Rs.5,000 in bonds are purchased. The first

column of Table-1 shows stock prices during one cycle of fluctuation below and back up to

the original price of Rs.50. The fifth column shows the adjustments called for by the 20 per

cent signal criterion.

The fourth column shows that by the end of the cycle the investor increased the total fund

from Rs.10,000 to Rs.10,209 even though starting and finishing prices were the same and

the stock never rose above the Rs.50 starting price.

Main limitation of the constant rupee value plan is that it requires some initial forecasting.

However, it does not require forecasting the extent to which upward fluctuations may reach.

In fact, a forecast of the extent of downward fluctuations is necessary since the conservative

portfolio must be large enough so that funds are always available for transfer to the stock

portfolio as its value shrinks. This step requires knowledge of how stock prices might go.

Then the required size of the conservative portfolio can be determined if the investor can

start his constant rupee fund when the stocks he is acquiring are not priced too far above the

lowest values to which they might fluctuate, he can obtain better overall results from a

constant- rupee- value plan.

2. Constant Ratio Plan:

The constant ratio plan goes one step beyond the constant rupee plan by establishing a fixed

percentage relationship between the aggressive and defensive components. Under both

plans the portfolio is forced to sell stocks as their prices rise and to buy stocks as their prices

fall.

Under the constant ratio plan, however, both the aggressive and defensive portions remain

in constant percentage of the portfolio’s total value. The problem posed by re- balancing

may mean missing intermediate price movements.

The constant ratio plan holder can adjust portfolio balance either at fixed) intervals or when

the portfolio moves away from the desired ratio by a fixed percentage.

Numerical Example:

The chosen ratio of stock to bonds is 1:1 meaning that the defensive and aggressive portions

will each make 50 per cent of the portfolio.

Therefore, we divide the initial Rs.10,000 equally into stock and bond portions. When the

stock portion rises or falls by 10 per cent from the desired ratio, the original ratio is

restored.

The sixth column indicates the four adjustments required to restore the 50:50 balances.

Even though stock price dropped considerably before rising back to the starting level, this

portfolio still made a little bit of money.

The advantage of the constant ratio plan is the automatism with which it forces the manager

to adjust counter cyclically his portfolio. This approach does not eliminate the necessary of

selecting individual securities, nor does it perform well if the prices of the selected

securities do not move with the market.

The major limitation for the constant ratio plan, however, is the use of bonds as a haven

stocks and bonds are money and capital market instruments, they tend to respond to the

same interest rate considerations in the present discounted evaluation framework.

This means, at times, they may both rise and decline in value at approximately the same

time. There is a limited advantage to be gained from shifting out of the rising stocks into the

bonds if, in the downturn, both securities prices decline.

If the decline in bond prices is of the same magnitude as those in stock prices, most, if not

all, of the gains from the constant ratio plan are eliminated. If the constant ratio plan is used,

it must be coordinated between securities that do not tend to move simultaneously in the

same direction and in the same magnitude.

3. Variable Ratio Plan:

Instead of maintaining a constant rupee amount in stocks or a constant ratio of stocks to

bonds, the variable ratio plan user steadily lowers the aggressive portion of the total

portfolio as stock prices rise, and steadily increase the aggressive portion as stock prices

fall.

By changing the proportions of defensive aggressive holdings, the investor is in effect

buying stock more aggressively as stock prices fall and selling stock more aggressively as

stock prices rise,

Numerical Example:

It illustrates another variable ratio plan. Starting price is Rs.50 per share. The portfolio is

divided into two equal portions as before, with Rs.5,000 in each portion. As the market

price drops, the value of the stock portion and the percentage of stock in the total portfolio

decline.

When the market price reaches Rs.50, a portfolio adjustment is triggered. The purchase of

57.5 shares raises the stock percentage to 70. As the stock price rises, the value of the stock

portion increases until a new portfolio adjustment is triggered. The sale of 51.76 shares

reduced the percentage of stock in the portfolio back to 50.

In the example, the portfolio was adjusted for a 20 per cent drop and when the price

returned to Rs.50. Other adjustment criteria would produce different outcomes. The highest

under this plan results from the larger transactions in the portfolio’s stock portion.

The portfolio adjustment section of (sixth column) may be compared with the same

columns. The variable ratio plan subjects the investor to more risk than the constant ratio

plan does. But with accurate forecasts the variable ratio plan designed to take greater

advantage of price fluctuations than the constant ratio plan does.

MS 44 IGNOU MBA Solved Assignment -Why is Company Analysis important for equity investment decision? What are the different methods of quantitative analysis used for equity investment decisions?

Why is Company Analysis important for equity investment decision? What are

the different methods of quantitative analysis used for equity investment decisions?

With so much at stake in the finance and investment world, there are constant debates

about investment performance, asset allocation, active vs. passive approaches, and more. In

this article, we review recent articles on the application of quantitative models to the

investment world - and look at the stock market's technical outlook. History can tell us

where we have been -- and a scientific and mathematical approach can help guide our

investment decisions going forward. Quantitative analytics can be applied to many areas

within finance, ranging from asset allocation and risk management to trading / investment

strategies and the growing interest in alternative assets.

Mystery of Underperformance

         In the July/August 2012 issue of the Financial Analysts Journal, Charles Ellis, CFA

wrote an interesting article entitled, "The Mystery of Underperformance (Murder on the

Orient Express)". Ellis writes how various funds -- including mutual funds, pension funds,

and endowments -- have a consistent pattern of underperformance. He states that

"…investment policies and decision-making processes -- no matter how complex they

might be to implement -- were all too often oversimplified, documented with 'selected' data,

and then crisply articulated as convincing 'universal truths'…" The article says that even

with the best intentions, investment practitioners systematically underperform due to varied

interests and motivations of each relevant party -- and that "many investment committees

have misdefined their objectives and are organized in ways that are counterproductive."

           In fact, analysis performed at the actuarial firm Kwasha Lipton (now a part of

PriceWaterhouseCoopers), quantified the level of potential underperformance for pension

plans and defined contribution plans. While at Kwasha Lipton, my team used a "utility

function" analysis to show that certain investment committee preferences could reduce

long-term performance.

MS 44 IGNOU MBA Solved Assignment Discuss the objectives and functions of Securities and Exchange

Discuss the objectives and functions of Securities and Exchange Board of India. 

Ans :-

       SEBI is the primary governing/regulatory body for the securities market in India. All transactions in the securities market in India are governed & regulated by SEBI. 

The main objectives of SEBI are:

(1) Regulation of Stock Exchanges:

    The first objective of SEBI is to regulate stock exchanges so that efficient services may

be provided to all the parties operating there.

(2) Protection to the Investors:

The capital market is meaningless in the absence of the investors. Therefore, it is important

to protect the interests of the investors.The protection of the interests of the investors means

protecting them from the wrong information given by the companies in their prospectus,

reducing the risk of delivery and payment, etc. Hence, the foremost objective of the SEBI is

to provide security to the investors.

(3) Checking the Insider Trading:

         Insider trading means the buying and selling of securities by those people’s directors

Promoters, etc. who have some secret information about the company and who wish to take

advantage of this secret information.This hurts the interests of the general investors. It was

very essential to check this tendency. Many steps have been taken to check inside trading

through the medium of the SEBI.

(4) Control over Brokers:

It is important to keep an eye on the activities of the brokers and other middlemen in order to control the capital market. To have a control over them, it was necessary to establish the SEBI.

Function :

         Another vital function of SEBI is to approve trading of stock indices in 2000 such as

S&P, CNX Nifty and Sensex as a convenient and effective product in order to ensure the

following functions in Indian securities:
• To monitor the stock market behavior.
• To benchmark portfolio performance.
• Used in derivative instruments such as index futures and options.
• Acts as passive fund management in Index funds. 

        The main functions of Security and Exchange Board of India is to introduce some

important regulatory measures, market registration norms with eligibility criteria, code of

conduct for intermediaries such as issue bankers, merchant bankers, brokers, sub-brokers,

registrars, portfolio managers, credit rating agencies and others connected to securities

market. In order to make the securities market safe and transparent to investors SEBI has

also introduced some bye-laws, risk dentification and risk management systems for clearing

houses of stock exchanges under its control.

          All these above regulatory actions introduced by SEBI have facilitate the following functions in stock market:

• Helps to regulate capital market.
• Monitor and checks trading of all securities in stock market.
• Checks any types of malpractices in securities market.
• Educate investors in securities market proving necessary guide lines.
• Control and regulate stock brokers and sub-brokers in securities market to maintain transparencies in trading.

Main objectives of SEBI in Indian security market:

• Development of functions in securities market in India.
• To protect the interest of investors with necessary guidance in securities market.
• Formulate rules and regulations for the securities market in India.
• Settlement of investors grievances in securities market.

The SEBI Governs the following

1. New Issues (Initial Public Offering or IPO)
2. Listing agreement of companies with Stock Exchanges
3. Trading Mechanisms
4. Investor Protection
5. Corporate disclosure by listed companies etc.

The SEBI is headquartered in Mumbai, India and has regional offices in the 4 metros.

The reason for creation of SEBI is to take care of these three group of people.

1. The Issuers of Securities (The companies)
2. The Investors (Us)
3. The Market Intermediaries (The brokers, DEMAT providers etc)

MS 44 IGNOU MBA Solved Assignment - What do you understand by risk

 Question 1). What do you understand by risk? Explain the various types of risks.

Ans.:

      What comes to your mind when someone says RISK or this investment is risky? Risk for most of the people has only one meaning loosing the principal amount. In scientific language “Risk may be taken as downside risk, the difference between the actual return and the expected return (when the actual return is less), or the uncertainty of that return.

Investment is related to saving but saving does not mean investment. (read difference between saving & investment) Investment is about deferring your present consumption for future goals with expectation of security of amount & getting returns. So there are 2 basic risks in it:

Investment Risk – it is about possibility of losing money. Today you invest Rs 5 lakh in equity & get Rs 4 after 3 years. Investment risk can be measured by Standard Deviation.

Inflation Risk – it is losing purchasing power of money. In 2011 you invest Rs 5 Lakh in debt & get Rs 10 Lakh in 2020. But your Rs 10 Lakh is not able to buy you the item which was available for Rs 4 Lakh in 2011.

Check below picture which tells you that with time (in equity) Investment risk is reduced & at some point of time it turns to zero. But on other hand Inflation risk increases with the time & there is no end to it. Or we can say in short term risk is volatility of assets & in long term it is loss of purchasing power.

2 most basic types of risk :

Systematic Risk Vs Unsystematic Risk

There is one more way to classify financial risk – is risk will impact whole economy or particular company or a sector.

Systematic Risk – it is also known as market risk or economic risk or non diversifiable risk & it impacts full economy or share market. Let’s say if interest rate will increase whole economy will slow down & there is no way to hide from this impact. As such there is no way to reduce systematic risk other than investing your money in some other country. Beta can be helpful in understanding this.

Unsystematic Risk – it affects a small part of economy or sometime even single company. Bad management or low demand in some particular sector will impact a single company or a single sector – such risks can be reduced by diversifying once investments. So this is also called Diversifiable Risk.

Different types of Risk in Investments

We have divided it into 2 parts – risk in debt & other risks. It is a big investment mistake if someone feels that there is no risk in debt investments – people who have ignored this in past have paid huge price.

Risk in Debt Investments

Credit Risk – it is also called default risk. As the first pic of this article shows that people only look at returns & not risk in it. Let me ask if SBI bank is paying some 9% interest & some NBFC NCD is paying 12.5% – which one you choose. If you think 12.5% NCD will be the right choice – you are ignoring the credit risk. Credit risk is when company doesn’t have capacity to pay principal or interest amount. In past there is a long list of companies which defaulted like CRB Capital, Escorts, Morpen Labs etc. Even Bank FDs have credit risk – there is guarantee only upto Rs 1 lakh. Credit risk is close to zero in Government Bonds.

This is most common & most important risk in debt – to understand it better read “Why debt will always give negative returns”

Interest Rate Risk – change in interest rate will impact price of bonds (or NCDs). There is negative relation between price of bond & interest rates – if interest rate will increase price of bond will go down & vice versa. This risk can be reduced if you hold bonds till maturity. Interest rate risk also affects Bank Fixed Deposit investor – he was having Rs 5 Lakh & he invests at a prevailing rate of 9%. What will happen if interest rate increase to 10% – he will be losing 1% interest. –

Reinvestment Risk – Let’s assume that you made investment in a bond with 9% yearly interest. Interest rate reduced to 7% in 1 year so next year when you received interest & went back to invest it was invested at lower rate.

Liquidity Risk – if you have some bonds that you would like to sell for immediate requirement but there is no buyer or fewer buyers than sellers – you may have to sell your bonds at discount.

Country risk – it is also called sovereign risk. As you read in Credit risk “Credit risk is close to zero in Government Bonds” but close to zero doesn’t mean zero. What about present condition of PIGS – Portugal, Ireland, Greece & Spain. Even in India there have been instances where fixed deposits issued by govt backed companies deferred maturity payments by issuing additional bonds. Country risk refers to the risk that a country won't be able to honor its financial commitments. When a country defaults on its obligations, this can harm the performance of all other financial instruments in that country as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options and futures that are issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit.

Inflation Risk – as mentioned in starting of the article. Inflation is your biggest enemy.

Other Investment Risks

Exchange Rate Risk – If you invest in debt or equity of some other country you will face exchange rate risk. If some of your US investments earn 10% in one year in dollar terms but the same year dollar loose 2% in comparison to rupee – your actual return will be 8%. NRIs are heavily impacted by this risk & they should make financial decision after considering it.

Timing Risk – I don’t think I need to explain it but only one suggestion – don’t take this risk.

Volatility Risk – equity prices keep fluctuating on day to day basis. This can be measured by standard deviation.

Political Risk or government risk or regulator risk – What will happen if you have invested in a particular sector & government comes out with an adverse policy. This risk can be clearly seen in sugar or oil & gas sector.

Valuation Risk – You may find a great company with great future prospects but if present valuation is too high you will not make money. Infosys was good company in 2000 & great company in 2005 but its price of 2005 peak was less than 2000.

Business Risk & Technology Risk – couple of years back pagers & typewriters were important part of once life but these products are no more there. Same happened with Audio tapes & floppies – what would have happened to these companies.

Execution risk – the time between when you see your price and when the trade actually goes to the market.

Concentration Risk – when you invest in single company (I know a person who invested all his long term savings in Satyam), single fund or single asset management company you are actually taking a huge risk.

Information Risk – This is again a very important risk to understand. You take your financial decisions based on some information – this information is provided either by manufacturer of financial products or agents/distributors/advisors or media. What will happen if this critical information is wrong or not complete? If you think this only happens at the time of buying insurance – you are absolutely wrong. This can happen in any financial product including mutual fund (you see advertisement of 100% return in a year – these are point to point returns & completely misguiding), taking loan (interest rate shown 9% but actually it is 16% – it is game of Flat rate & Reducing rate) or even simple products like tax free infrastructure bonds.

Market Risk - This is the most familiar of all risks. Also referred to as volatility, market risk is the the day-to-day fluctuations in a stock's price. Market risk applies mainly to stocks and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear market - volatility is not so much a cause but an effect of certain market forces. Volatility is a measure of risk because it refers to the behavior, or "temperament", of your investment rather than the reason for this behavior. Because market movement is the reason why people can make money from stocks, volatility is essential for returns, and the more unstable the investment the more chance there is that it will experience a dramatic change in either direction

There are few other risk which impacts you directly or indirectly – institutional risk, operational risk, event risk, company risk, geopolitical risk, sociopolitical risk, counter-party risk, reputation risk, commodity risk, management risk, principal risk, opportunity risk, prepayment risk, call risk, legal risk and I am sure I have missed lot others….

Think about risk in two ways:

• Your ability or capacity to take risk. This is all about your financial circumstances and goals. If you have more wealth and can invest over longer periods, you may be more able to accept a higher degree of risk.
• Your attitude or willingness. This is more of a mental approach. Some people may not be able to sleep at night at the thought that their investment can fall in value rather than rise.

The risk profiles below may help you identify what sort of investor you are.
 

No risk

• Preserving your capital is the most important factor when you consider your savings. This means that you are more likely to restrict your savings (for growth or income needs) to cash deposits, cash ISAs, interest bearing savings accounts and similar products that also offer ready access to your money and are covered under a depositor protection scheme.
• You understand the effects of inflation on your capital (and any interest received) and how this can reduce the real value of your money over time.
• See our range of savings accounts

Low risk

• The opportunity to achieve reasonable returns (for growth or income needs) is important to you but you wish to invest in a way that aims to preserve more of your capital if markets fall. You may have little or no experience in taking investment risks but accept this may be necessary to achieve returns potentially equivalent to or higher than those available from cash deposits. You understand that this could involve your capital being invested for five years or more with low to medium exposure to stocks and shares and other more riskier investments. 
• You understand that the value of any investments you make will fluctuate and you might get back less (or more) than you invested (at maturity or earlier).

Medium risk

• The opportunity to achieve attractive returns (for growth or income needs) is very important to you but you also want to invest in a way that does not expose all of your capital to more riskier investments. You have some experience in taking investment risks and accept this is necessary to achieve potential returns much higher than those available from cash deposits. You understand that this could involve your capital being invested for five years or more with medium to medium high exposure to stocks and shares and other more riskier investments.
• You understand that the value of any investments you make will fluctuate and you might get back less (or more) than you invested (at maturity or earlier).

High risk

• You are an experienced investor and are prepared to take on very high levels of investment risk that offer the potential to achieve exceptional returns. This opportunity to achieve exceptional returns (for growth or income needs) is a key priority for you – even in circumstances where it might pose a significant risk to some or all of your underlying capital. You understand that a high-risk investment could involve your capital being invested for five years or more with maximum (up to 100%) exposure to stocks and shares and other more riskier investments. 
• You understand that the value of any investments you make will fluctuate and you might get back much less (or much more) than you invested (at maturity or earlier).
   

Other important considerations
Understanding your attitude to risk (ATR) is just one of many important considerations when deciding whether to invest, and how much risk to take. We have outlined a few of these considerations below:

Ability to bear losses – what can you afford to lose if things go wrong?

Your other financial planning needs – should investing be your priority?

What are the main types of risk associated with investments?

What's my next move?

• If you’re comfortable making your own investment decisions without the help of a financial adviser, you can view our range of investment products, read our brochures and apply online from just £3,000.
• If you would like assistance or are an existing Barclays customer and would like to make an application by telephone, please call 0800 445443 ¹.

Remember: if you are unsure if an investment is right for you, please seek independent financial advice.