It's All About Risk!

It's All About Risk!
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Introduction
The Role of The Underwriter
Different Risk Models

Investing money in shares is all about risk. Every investor will expect some form of return based on their investment. This will of course have an element of risk. The greater the potential return on an investment will mean a greater risk element.

The world of finance is not merely about buying and selling shares. As we said at the start of this financial economics section, the role of finance is to provide business with capital and to provide the owners of capital with an income.

THE ROLE OF THE UNDERWRITER

Within the sphere of finance there is a underwriter role where someone will agree to guarantee investment projects take place should the project fail to attract sufficient investment on their own merits. The underwriter will agree to underwrite projects on the agreement of getting extra returns on the investment.

It is down to the underwriter to assess the potential risk of any project seeking finance. The underwriter will structure their risk assessment of any project. The underwriter will present the risk data in any published advertisement for finance.

DIFFERENT RISK MODELS

The way in which we analysis risk is varied, the two most common example given in textbooks are:

THE EXPECTED RETURN MODEL: This is a simple model based on the logic of multiplying the success potential of a project against the potential return.

If we say a new investment is expected to have a return of 10% success rating with the potential return $200, the expected return would be worked out as follows:

= Potential Success x The Return

= 0.10 (10%) x $200

= $20

This expected return is a benchmark figure which can be applied in any further analysis, in essence it is the minimum amount you would expect to see on an investment.

CLASSICAL MARGINAL UTILITY ANALYSIS: This analysis involves looking at the potential benefit gained from consuming a good On the whole this should be positive (the expected return), but it can be negative (to lose money).

We as individuals will all have diminishing marginal utility when we consume too much of a particular good. In the sense of the stock market and investment it will the point where the return on investment reaches the point where we are happy with the investment. It's all about our own personal tastes and reaching a point of bliss.

The problem with the classical theory is that no assumption of risk takes place. So the classical theory is not quite sufficient as it does not any assumption of risk, just that investments will make a return.

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