Adding a Risk-Free Asset Assignment help
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A Risk-Free Asset has a guaranteed return in future. Practically All financial assets have some level of risk involved. For example, Treasury Bills issued by the government as considered risk free as they provide a guaranteed return on principal and interest.
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Importance of Risk-Free Asset in Portfolio
The market can change at any time. There may be rises or falls frequently or a complete crash, assets like T-Bills which may appear dull in Bull-Market as they provide a low rate of return will change into gold when the market crashes. The assets in a portfolio should take into consideration both long-term and short-term factors.
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What is Risk?
The Risk in an Investment is measured by the difference between the actual rate and anticipated return. Market conditions are hard to foretell so the not known aspect of future return is the risk. Risk-Free Assets provide a reasonable profit at the level anticipated. Since the gain is more or less guarantee therefore the rate of return from T-Bills is less s compared to risky assets like stocks.
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Risks associated with Risk-Free Assets:
- Inflation Risk: Long term investments are not adverse to inflationary pressures, for example, In 1926 the real inflation rate return on T-Bills issued in the US averaged 0.7%.
- Income Risk: If the income falls sharply in a short span of time with declining short-term interest rates then the return of the T-Bills also have a downfall. For example, in mid-March 2009 quarterly T-Bills were providing 0.45% return down from 2% in 2008.
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How to properly use Risk-Free Assets in your investment portfolio:
- T-Bills don’t face credit or interest rate risk but do face inflationary and income risk. For Long term investors, the declining amount over a period due to inflation should be taken into account.
- T-Bills should not be sold when the market is down or any financial emergencies.
- Investment in Stocks should also be considered to nullify the long term decline in value of T-Bills. T-Bills should be used as an investment option to downsize the risk by a large stock in a bull market.
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