Question

Describe the risk and return profiles of various investment vehicles and the importance of diversification

Answer 1

investment vehicle risk expected return

CDs low low

US securities low low

Corporate bonds low/medium low/medium

Stocks medium/high medium/high

Options high high

Futures high high

Pension funds low low

Mutual funds medium medium

etc.

Usually risk and expected returns are closely related, i.e. low risk investment yield lower return rates. In order for an investor to try to increase return rates and at the same time keep risk under control, they can diversify their investment portfolio. Diversification means investing in different types of vehicles.

For example, mutual funds and retirement accounts are pooled investment vehicles that invest in several different types of assets in order to reduce risk and increase return rates. For example, invest a certain % in stocks (high risk/high returns), another % in corporate bonds (medium risk/medium returns) and the rest in US securities (low risk/low returns).

Answer 2

Stocks: The risk is high as they are constantly fluctuating is price as market operations go on and on.

CDs: The risk is very low as they are instruments with a fixed rate of return.

Bounds: They have a low risk as they have the company fixed assets as collateral.

IPO's: The risk is high as it is the initial participation of an enterprise in the stock market, therefore there is a lot of speculation investments that affect the actual value. E.g. Big social media stocks

Futures: They have a medium risk as the company that is entitled to sell the product could not be able to meet the commitment.

The importance of diversification is to leverage in different instruments so the risk is spread among different companies.