The overall aim of every investor is to make a profit. There are various investment tools that are designed to meet the specific needs of the investor. Thus, depending on the investment goals and objectives, an investor can opt for an investment option that best suit his needs. There are both long-term investment and as well short term investment tools. The long-term investments are generally considered to be investments that an investor wishes to hold for a period of more than one year. On the other hand, short term investments refer to the investments that are likely to expire or be liquidated at any time with ease. Companies that have strong cash position invest the excess cash in short term investments. Risk is one of the fundamentals of investments. It is impossible to discuss investment returns without a mention of the investment risks that are involved. The challenge for the investors is the determination of what constitutes risks and as well the determination of low and high risk investments. In this paper, we shall explore why investors may be attracted to high risk investments, assess the associated risks, discuss challenges, analyze ethical violations, consequences to the management who violate ethical requirements and as well a scenario where high risk investments would be beneficial to the investor.
The relationship between risk and returns is that high risk investments have a high potential for returns. The problem is that risk is not readily quantifiable and it is enshrined in various uncertainties. Several scholars have tried to use volatility in the definition of risks. Thus products that have higher price volatility are considered to have high risk. However, volatility is not always related to the risk as there are some financial instruments whose value oscillates but in the end, the final redeeming price is defined. Thus, risk can be explained as a probability that an asset will experience a permanent loose of value or fail to meet the investor’s expectation. With that definition, a high risk investment is one that has a high chance that the investment will experience a loss in the capital invested or below expectations performances.
In spite of the high probability that the investments are likely to end either in a loss of capital or below expectation returns, high risk investments attract many investors for various reasons. The main reason why some investors prefer high risk investment is that there is a potential for high income. Thus, investors looking for high returns, and have the financial strength to absorb the associated risks opt for high returns. In some cases, institutional investors are under instructions from investors who wish to collect regular returns from their investment. Thus, the institutional investor will require investing in high risk products that have high returns within a short period. This is in order for the investor to meet the liquidity needs of an organization. Analysts may pick a portfolio that is considered risky based on their experience including investments such as venture capital trusts. In such investments, an investor will pick small companies that are expected to perform well in future. Spread betting, unregulated stocks amongst others (HSBC, n.d.).
Exchange traded derivatives is a financial instrument whose value is pegged on the value of a different asset. They are standardized derivative contracts that are used to hedge risks that on a wide range of investments. Exchange traded derivatives have gained more popularity over the over-the-counter securities. They advantages of using exchange traded derivatives is that there is standardization, liquidity and as well elimination of default risk. Standardization entails the inclusion of specific standards for a particular contract. The two main exchange traded derivatives include the futures and options. Below are some of the risks that are associated with the exchange traded derivatives:
Danger of leverage
Future contracts are traded in the open air market. They command a price range of 5-10% of the contract value. In the event that a buyer chooses the wrong direction in the price movement, the loss incurred is large owing to the costs of the futures.
Complicate products
The futures are complicated products in that individual investor may not easily understand them and as well the terms of the contracts. Thus they are only traded by registered brokers (Telser, 1996).
Price Limits
In many products, there is a daily price limit. Owing to these price fluctuations, the price will quickly reach limit thus making the investor unable to trade the instrument. In some cases, if the prices shift permanently, the trader is stuck with the contract (Edward, 1992).
Large margin deposits
For new small scale traders, the amount of deposit required in spite of the fact that it is a small percentage, the dollar value is usually large and thus limiting small scale traders.
Finally, unlike over-the-counter traded securities, diversification does not reduce the systematic risks. Also, hedging offers only a partial hedge as the contract is for the change in a particular direction (Hull, 2006).
In order for an investor to minimize the possible risks, it is paramount to understand the market that one is trading in. This will enable one to make an informed decision on the possible price movement. One should also be aware of the fact that they can lose more than the invested amount and thus should be ready to accept the possible losses (US Security Exchange Commission, n.d.). Diversify the assets in terms of the number of markets and as well the maturity dates (The Money Advice, 2015).
Owing to the complexity of the organization structures financial firms that have global presence, the government and other regulatory bodies often faces challenges in implementing policies and as well monitoring their activities. This is because they operates in multiple jurisdictions and have vast resources to fight any legal battle that comes to them. To improve the capacity of the governing bodies, there is need for countries to agree on standardized procedures that will govern their operations. Individual countries should develop laws that ensure that companies are governed by the rule of the land as long as they operate there regardless of the country of incorporation (Levy-Lang, 2011).
A case example is Worldcom, the CEO of the company planned a merger that saw the company merge with Sprint. Bernard Ebbers had substantial shares that he margined to create other personal businesses. The share prices deepen and the banks came knocking, he convinced the board to lend him 400 million to cater for the loan. To keep the company financial strength looking good to the investors and financiers, he falsified the financial statement. Thus all the investors who acted on his misinformation suffered massive losses after the irregularity was discovered (Romar & Calkins, 2015).
All the CEOs that are found luring investors to invest in their companies based on falsified information should face the full action of the law. Their license should be cancelled and the management of their company should go under receivership management.
High risk investments are ideal when there is a limited time for the investors and there is need for cash flow. Thus, an investor will focus on short –term investment options that have potential for high profit margin.
References
Brodsky, W., Hecht, L., & Lovecchio, L. (January 01, 1986). Futures and options. Euromoney.
Edwards, F. R., & Ma, C. W. (1992). Futures and options. New York: McGraw-Hill.
Hull, J. (2006). Options, futures, and other derivatives. Upper Saddle River, N.J: Pearson/Prentice Hall.
HSBC. (n.d.). Factors affecting Investment Decisions | HSBC India. Retrieved from http://www.hsbc.co.in/1/2/personal/investments/new-invest/new-invest-factor-affecting
Levy-Lang, A. (2011, May 29). Financial regulation: facing a global challenge. Retrieved from http://www.paristechreview.com/2011/05/09/financial-regulation-facing-global-challenge/
Romar, E. J., & Calkins, M. (2015). WorldCom Case Study Update - Resources - Business Ethics - Focus Areas - Markkula Center for Applied Ethics - Santa Clara University. Retrieved from https://www.scu.edu/ethics/focus-areas/business-ethics/resources/worldcom-case-study-update/
Telser, L. G., Barro, R. J., & French, K. R. (January 01, 1996). Futures and options markets. Journal of Business, 1996.
The Money Advice. (2015). High-risk investment products - Money Advice Service. Retrieved from https://www.moneyadviceservice.org.uk/en/articles/high-risk-investment-products
US Security Exchange Commission. (n.d.). Ten Things to Consider Before You Make Investing Decisions. Retrieved from https://www.sec.gov/investor/pubs/tenthingstoconsider.htm
