Investment Scenarios and Risks: A Comprehensive Analysis

First Exercise

Scenario A

You are an investor of 55 years of age that has saved 450.000€ after years of working. Since you are thinking on your retirement, you have developed a more risk averse character. Until the day you retire, exactly 10 years from today, you purchase a financial product that will pay a 7,5 % guaranteed dividend. This investment has a maturity date of 10 years. Once you retire at the age of 65 you won’t invest in anything else and the money you have you plan to spend it all until the day you die at the age of 100 years of age.

After explaining this decision to your financial advisor, she suggests that there are some financial products that would give you a monthly payment of X until the day you die regarding the age. With the amount that you have saved up to today the insurance company offers you a payment of 3% yearly.

Scenario B

You are considering buying a house for your upcoming family. You have saved up 100.000€ and your parents will contribute with a gift of 50.000€. After months of looking for the right investment you finally find a house that the selling price is 600.0000€. After purchasing the house, you decide to rent it to students at European University for the next 5 years. You agree with them that the price will not be adjusted by inflation and they will have to pay 1.500€ per month for a 4-bedroom apartment and they will have to rent it even during the months that there is no class. The students then decide to rent it to their friends for the summertime at a price of 2.000€ per month for a total of 3 months per year.

Scenario C

A friend of yours has contacted you and encourages you on starting a partnership together. You would be acting as the investor and would own 50% of the company. He asks for 5.000€ to start the business and he would issue 10 shares, constituting the company. After one years of working, the company pays the first dividend of 10€ a share. The second year it pays 15€ a share. The third you develop a new technique/improvement on your product and the dividend of that year is 35.000€ a share. The fourth and fifth years you get paid a dividend of 150.000€ per share. The fifth year on top of the dividend you sell two of your shares to a financial institution for the value of 500.000€.

Calculate the following:

• Scenario A 

Determine the Future Value of the first financial product.

Determine the monthly amount that you would be receiving if you take the option offered by the insurance company.

Argue what decision would be best if you lived up to a 100. At what age would you decide that the second decision is best?

• Scenario B

Calculate the NPV of the investment for the selected period being the income from the rent the CF of the investment. Take into account that your opportunity cost is to invest the money that you have (not your parent’s money) in a financial product that will pay a 2,5% monthly rate for the same period of time. What investment would you decide?

• Scenario C

What is the cost?

What is the income?

What is the profit on your investment?

What is your Holding period return?

Explain in detail (at least two sentence) which of the following risks should be associated to each of the investments explained in the scenarios. Consider both the side of the person investing and the person that is loaning you the money, operating the business, etc.

• Credit Risk
• Liquidity Risk
• Market Risk
• Operational Risk
• Solvency Risk
• Regulatory Risk
• Legal Risk
• Tail Risk
• Accounting Risk

Explain in detail which of the following examples are systematic or unsystematic risk.

• The Food and Drug Administration has prohibited Nestles new cookies.
• Apple names Time Cook as their new CEO.
• An earthquake destroys a Lithium mine in Chile.
• The governments on the world agree to introduce a new accounting policy.
• The workers of Coca-Cola go on a strike to protest for a raise on their salaries.
• The ECB (European Central Bank) decides to cut interest rates by 0.25%.
• Iraq and Iran go to war affecting the oil prices of the world.
• A new gold mine is found.