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Risks And Rewards Associated With Short-Term Investments

 Short-Term Investments

 Short-Term Investments

 Short-term investments are typically held for a duration of one year or less? These investments are often sought after by individuals and organizations looking to park their funds temporarily while seeking better returns than traditional savings accounts. Short-term investments can include various instruments such as treasury bills, certificates of deposit, and commercial paper.

 

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    Example:

    An individual invests in a 6-month treasury bill with a face value of $10,000 and an annual interest rate of 2%. 
    

    Identifying Risks Associated with Short-Term Investments

    Not All Risks Are Created Equal

    Interest Rate Risk: This risk arises from fluctuations in interest rates, impacting the value of fixed-income securities. For example, when interest rates rise, the value of existing bonds decreases, leading to potential capital losses for the investor.

    Liquidity Risk: Short-term investments may face liquidity risk, where the investor may not be able to sell the investment at a fair price due to a lack of market demand. This can result in the investor being unable to access their funds when needed.

    Example:

    An investor purchases a commercial paper with a maturity of 90 days, but due to market conditions, they are unable to find a buyer when they need to liquidate the investment.
    

    Assessing Rewards of Short-Term Investments

    Assessing Rewards of Short-Term Investments

    Yield: The potential return on short-term investments is a key factor in assessing their attractiveness. Calculating the yield allows investors to compare different investment options and make informed decisions based on potential returns.

    Tax Efficiency: Short-term investments can offer tax advantages, especially in comparison to longer-term investments. Understanding the tax implications and benefits can be crucial in evaluating the overall rewards of these investments.

    Example:

    An investor compares the yields of a 6-month certificate of deposit and a 1-year treasury bill to determine the most rewarding option.
    

    Mitigating Risks in Short-Term Investments

    Assessing Rewards of Short-Term Investments

    Diversification: By spreading investments across different short-term instruments and asset classes, investors can reduce the impact of any single investment’s underperformance.

    Risk-Adjusted Returns: Evaluating investments based on their risk-adjusted returns helps in identifying the most efficient use of capital, considering the level of risk involved.

    Example:

    An institutional investor diversifies their short-term investment portfolio by allocating funds to treasury bills, money market funds, and short-term corporate bonds.
    

     

    Short-term investments offer opportunities for individuals and organizations to earn returns on their idle funds, but they also come with inherent risks that need to be carefully evaluated. 

    RISK AND REWARD

    To do: Research and compile a list of short-term investment options, along with their associated risks and potential rewards.

    Short step-by-step plan:

    1. Identify short-term investment options:

    • Research and make a list of short-term investment options such as money market funds, certificates of deposit, and short-term bonds.

    1. Research the risks associated with each investment:

    • Use reputable financial websites, investment books, and resources to understand the potential risks involved with each investment option. For example, note the risks of market fluctuations, interest rate changes, and credit risks associated with each investment.

    1. Evaluate the potential rewards:

    • Research and compare the potential returns of each investment option. Consider factors such as interest rates, dividend yields, and potential capital gains.

    1. Compile a comprehensive list:

    • Create a clear and organized list of short-term investment options, along with their associated risks and potential rewards. This could be in the form of a table or spreadsheet for easy comparison.

    1. Review and analyze the information:

    • Analyze the compiled information to gain a clear understanding of the risks and rewards associated with each investment option.

    1. Make informed decisions:

    • Use the compiled list to make informed decisions about short-term investment options based on your risk tolerance and financial goals.

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