Bus - Fin 2nd Q Lesson 2 093611

Investing is a process of making money grow and have a return.
But in every type of investment, each

has its own level of risk and return. The higher the potential return on top of the investment, the higher
the risk or uncertainties that even the investment aside from the promised return will not be recovered.
Investments are typically categorized according to their corresponding risks and returns. As a rule, the
higher the return, the higher will be the risk. But that the rule is not necessarily true in reverse order
that higher risk would translate into higher potential reward. Sometimes greater risk is just greater risk
with little potential return. Risk isn’t a bad thing. But there is a need to understand what kind of risks the
investment can take and how to reduce unacceptable levels of risk.
1. Determination of tolerance to different kinds of risks
Every investment involves some level of risks. Understanding the type of risk, or the combination of
types of risk, is essential in reducing those risks. Two factors that can help determine the risk tolerance:
a. Net worth - is assets minus capital b. Risk capital - is money that, if lost on an investment, won’t
impact the financial position and lifestyle.
If there is a high net worth and substantial risk capital, the risk tolerance if higher.
But if the net worth is modest or nothing, and the risk capital is not much, it’s probable to be better off
with conservative, low-risk investment.
2. Conducting due diligence
This means making research about the investment instruments before finalizing the investment plan.
Checking out the investment’s history, earnings’ growth, management team and debt load will provide
more information about the investment portfolio. This information can be compared with other similar
investment products as well as to other assets in the investment portfolio.
The data about the stock’s price- to- earnings ratio or P/E ratio will measure the relationship between a
company’s stock price and its annual after-tax earnings. A company with a significantly higher P/E ratio
than other comparable companies in the same industry typically involves a higher risk. Investment risk
can be minimized by weeding out stocks with high P/E ratios, unstable management and inconsistent
earnings and sales growth.
3. Diversification of investment portfolio
Diversification of investment portfolio is the risk management strategy of combining a variety of assets
to reduce the overall risk of an investment portfolio. One of its purposes is portfolio risk management.
Diversification of investment portfolio also lowers its volatility as movements or changes are not
expected to happen at the same time in all asset categories, industries, or stocks. The decrease in the
instability of the portfolio considers that the different assets market price can rise and fall at different
time intervals. This results to a well balance risk and return or risk is spread over a variety of products.
For example, investment money can be made as follows:
A. 25% into ABC stock
B. 25% into time certificate of deposit
C. 25% into Treasury bonds; and
D. 25% into real estate.
Profit is realized when there will be an increase in the market price of stock of ABC company. But this
profit potential is reduced by the fact that only a portion of the money is invested in the said stock.
However, if ABC Company fails, the loss is also limited, because 75% of the money is invested in other
products.
4. Monitoring of investments
Regular reallocation of resources is necessary for control purposes. Proper allocation of the investments
depends on such factors as age, investment period and investment temperament.
For example, it is necessary to evaluate holdings at least once a year for an investment portfolio
consisting of 40% in intermediate-term bonds, 25% in large capital stocks, 10% in short-term bonds, 10%
in medium capital stocks, 10% in small capital stocks and 5% in international stocks. This is to assess
whether there is a need to buy or sell assets to bring the portfolio back to proper asset allocation.
5. Taking advantage of government guaranteed investment products
It is very safe to invest in an instrument which is guaranteed by the government like Treasury bonds.
These securities are fully backed by the Philippine government aside from an insurance from the
Philippine Deposit Insurance Corporation. In addition, holding investment until its maturity is better than
early withdrawal considering the market risks and penalties except for a secured recovery of principal
and interest.
Categories of investment risk and its example:
1. Systematic Risk
Systematic risk is associated with the market. This risk affects the overall market of the security. It is
unpredictable and undiversifiable. However, the risk can be mitigated through hedging.
For example, political upheaval is a systematic risk that can affect multiple financial markets, such as the
bond, stock, and currency markets. An investor can hedge against this sort of risk by buying put options
in the market itself.
2. Unsystematic Risk
The second category of risk, unsystematic risk, is associated with a company or sector. It is also known as
diversifiable risk and can be mitigated through asset diversification. This risk is only inherent to a specific
stock or industry. If an investor buys an oil stock, he assumes the risk associated with both the oil
industry and the company itself.
For example, suppose an investor has invested in an oil company, and he believes the falling price of oil
affects the company. The investor may look to take the opposite side of, or hedge, his position by buying
a put option on crude oil or on the company, or he may look to mitigate the risk through diversification
by buying stock in retail or airline companies. He mitigates some of the risk if he takes these routes to
protect his exposure to the oil industry. If he is not concerned with risk management, the company's
stock and oil price could drop significantly, and he could lose his entire investment, severely impacting
his portfolio.

Bus - Fin 2nd Q Lesson 2 093611

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Investing is a process of making money grow and have a return.

But in every type of investment, each

1. Determination of tolerance to different kinds of risks

2. Conducting due diligence

A. 25% into ABC stock

B. 25% into time certificate of deposit

C. 25% into Treasury bonds; and

D. 25% into real estate.

Categories of investment risk and its example:

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