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Flashcards in The Client's Risk Profile Deck (6)
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1

Major Types of Investment Risk

Capital - investment may be worth less in future
However, by being cautious of CR and saving, investors expose themselves to other risks:

1. Inflation - future purchasing power of the capital base + interest eroded by inflation (Deposit interest rate < Inflation)

2. Interest Rate - BoE base rate likely to change over time and feed into deposit rates.

3. Shortfall - investment returns falls short of investors objective.

2

Other types of Investment Risk

4. Credit - loss of value of debt investment due to default (relevant to Corporate Bonds)

5. Market - loss of value due to fluctuation in market determined prices, interest or exchange rates. general risk of investing in market traded securities (e.g interest rates cause bond prices to fall, exchange rate affects foreign investments)

6. Operational - failure of institution due to poor operating procedures. e.g. fraudulent activity of trader

3

Diversification

No asset class has low risk in all areas

Cash has low capital, but high shortfall
Equity has high capital, but low interest, inflation and shortfall

Diversified portfolio can reduce aspects of risk, however allocation must be appropriate to client

4

3 Pillars of client's Risk Profile

1. Risk Required - level of risk required in order to reach return objectives

2. Risk Capacity - client's ability to absorb financial losses

3. Risk Tolerance - level client is comfortable with

5

Factors affecting the Risk Profile

Timescale - more risky, longer timescale

Amount of Risk Capital - excess money available which would not affect client's life if lost

Investment Experience - greater experience, greater tolerance

Psychology - client's attitude to volatility and loss

6

Methods of Determining a Client's Risk Profile

1. Fact-find and Risk Questionnaire
(questionnaire that forms basis of wider discussion with fact find to fit KYC requirements)

1. Risk Tolerance - review clients previous investments, may be comfortable or reluctant for further loss

2. Risk Capacity - Uses the outcome of the questionnaire and matches to their financial situation
(risk capital)

Using the risk profile, you can agree appropriate asset allocation