Name ____________________________ Class ______________________ Date __________
INVESTMENTS: BUILDING YOUR PORTFOLIO
Assessing Risk and Reward
3
When financial advisors analyze different kinds of investments, they consider four
kinds of risks.
Financial Risk: Financial risk is the risk that an investor can lose money. The more
certain an investor is of recovering the original investment, the lower the financial
risk. Some investments pay regular rewards. Savings accounts pay interest every day,
month, quarter, or year—depending on the terms of the account. When companies are
profitable, they issue dividends to their stockholders, paying each stockholder some
portion of the company’s earnings.
Market Price Risk: Market price risk considers the certainty that the value of the
investment will go up or down. Investments with fixed rates of return have lower market
price risk. Those with highly variable rates of return have greater market price risk.
Inflation Risk: Inflation risk is the risk that the return on an investment will be lower
than the rate of inflation. This risk must take into account the return on the investment
and the rate of inflation—the rate at which overall prices are rising in the economy—
over a given period of time.
Liquidity Risk: Liquidity is a measure of how easily an investment can be turned
into cash. Savings accounts, which can be accessed on demand, have high liquidity.
Investments with a fixed term and penalties for early withdrawal have lower liquidity.
◆ Based on the information above and the descriptions below, evaluate different kinds of
investments. Rate them on a scale of 1 to 5 for each type of risk. A score of “1” indicates the
least risky and “5” indicates the most risky. After you have rated each type of investment,
write a brief paragraph assessing its risks and rewards. Give specific reasons for your answer.
Tell whether the investment would appeal to a younger or older investor and explain why.
1. Savings Account Savings accounts are insured up to $250,000 by the federal
government through the FDIC. They earn interest, but at a very low rate. Money can
be easily withdrawn.
Financial Risk
1
2
3
4
5
Market Price Risk
1
2
3
4
5
Inflation Risk
1
2
3
4
5
Liquidity Risk
1
2
3
4
5
2. Certificates of Deposit CDs are insured by the FDIC. They pay slightly higher
interest than savings accounts but have a fixed term during which the money must be
left in the account. The investor can withdraw the money before the term is over, but
must pay a penalty. CDs typically require a larger starting investment than savings
accounts, and it is not possible to add to the size of the investment during the term.
Financial Risk
Market Price Risk
Inflation Risk
Liquidity Risk
1
1
1
1
2
2
2
2
3
3
3
3
4
4
4
4
5
5
5
5
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48
Name ____________________________ Class ______________________ Date __________
INVESTMENTS: BUILDING YOUR PORTFOLIO
Assessing Risk and Reward (continued)
3
3. Money Market Accounts Money market accounts pay slightly higher interest than
savings accounts. Savings accounts are FDIC insured. Money market mutual funds are
not. An investor can easily withdraw money. Money market accounts require a larger
initial investment than savings accounts; like a savings account and unlike a CD, an
investor can add to the account.
Financial Risk
1
2
3
4
5
Market Price Risk
1
2
3
4
5
Inflation Risk
1
2
3
4
5
Liquidity Risk
1
2
3
4
5
4. Bonds Bonds are relatively low-risk investments but not FDIC-insured—bond issuers
may default, or be unable to repay the bond. Bonds pay a fixed interest rate, which is
usually higher than savings accounts, CDs, or money market accounts. The interest
rates offered on newer bonds can affect the value of the bond if an investor wishes to
sell it—higher rates on newer bonds will make bonds already held less attractive, and
vice versa. Bonds typically require a relatively high initial investment, and an investor
cannot add to the value of a bond during its life—though he or she may invest in other
bonds. Selling a bond early may incur a penalty.
Financial Risk
1
2
3
4
5
Market Price Risk
1
2
3
4
5
Inflation Risk
1
2
3
4
5
Liquidity Risk
1
2
3
4
5
5. Stocks Buying shares in a company offers the greatest potential reward, if the stock
rises greatly in value, and the greatest possible risk, if it falls far. The cost of buying
stocks depends on the price of a particular company’s shares. Stocks are generally
easy to sell, although not always at a profit. Financial advisors constantly remind
investors of the need to view stocks as a long-term investment.
Financial Risk
1
2
3
4
5
Market Price Risk
1
2
3
4
5
Inflation Risk
1
2
3
4
5
Liquidity Risk
1
2
3
4
5
6. Mutual Funds Stock and bond mutual funds have similar characteristics to individual
stocks or bonds, with some exceptions. The initial price of a mutual fund may be smaller.
Mutual fund managers invest in many different companies’ or governments’ stocks
or bonds, which may reduce risk—depending on the judgment of the fund manager
and overall market conditions. Investors can easily add to their investments by buying
more shares of a fund. Investors can also sell their shares of a fund with relative ease.
Financial Risk
Market Price Risk
Inflation Risk
Liquidity Risk
1
1
1
1
2
2
2
2
3
3
3
3
4
4
4
4
5
5
5
5
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49