In which of the following cases would you be more likely to decide whether to take on the risk involved by looking at a measure of the value at risk?
A. You are unemployed and are considerate invested your life savings of $ 10,000 to start up a new business.
B. You have a full-time job paying $100,000 a year and are considering making a $ 10,000 investment in the stock of a well-established, stable company.
Explain your reasoning.
Scenario A seems to be a very risky, last ditch effort to make something of your life. I would think Scenario B has less risk, though of course, both scenarios have their fair share of risk. You have to be very careful if you are going to invest all of your savings in a business during an economic recession.
Having a steady source of income makes it easier to take on the risk of the 10k investment. As for option A I think I personally would need a lot more information before I would take such a potentially devastating risk. How risky is the start-up business? How much research have a done about the need, market, product/service I will be dealing with? Will there be other investors? What kind of business is it? How much do I know about the business before I start trying to "do" that business?
Before the value at risk can be estimated you need to know the probability that the $10000 that is being invested to start your new business would actually lead to a profit making proposition. Assuming you could lose all of the $10000 or it becomes double with an equal probability, the VaR is 100%.
Though in the two cases you have described the value of risk is less important than what the $10000 means to you. For a person earning $100000 losing the entire $10000 is not going to lead to a major change in his life. He could live on $90000 with approximately the same level of comfort as he could on $100000. But your losing the last $10000 you have could mean your ending up on the street with no food. On the other hand, if your business venture succeeds the same $10000 could change your entire life. It is a risk that you have to decide if you are willing to take on.
I would have to agree with the majority here. While both options are risky, option B seems to be less risky. That being said, option B only states how much the person makes and not if they have a savings. Therefore, does the person in option B have the funds to take the risk on hand? I know that this is not actually part of the question, but it left me wondering.
Post #4 makes a good point - the risk of great loss and the potential for great gain is present with either of the options. As a percentage of your capital prior to making the decision to invest the $10,000, option A is obviously the much higher risk to your base value. If you decide to invest and do not get a positive return from your investment, your personal capital will be much more negatively impacted in option A.
The first option is definitely more risky due to the fact that there is no safety net. You are basically giving up your whole life savings. The second option is only ten percent of your money and you might actually do well, as the company is solid. But even if you lose money, it probably won't be the whole 10,000. There are other variables as well. Does the stock pay dividends? In the end, the greater risk is opton one.
Neither of these previous posts pays any attention to the idea of value at risk. VAR is measured by looking at what the potential for loss is and what the potential for gain is, both over a given time period.
Option A has more potential for loss and gain. You could lose your whole $10,000, but you could presumably make a really large return as well. Option B has less risk but less reward as well. Therefore these are probably relatively equal in terms of VAR.
I think it would be very risky to choose option A, whereas option B seems to make some good sense. Option A might leave one not only unemployed but also genuinely impoverished, especially if a financial emergency arose. Option B might simply mean that one loses $10K -- not a good thing, but not a disaster, either.
I think that in scenario A you might feel like you don't have any other choice, and you might be tired of being unemployed and want to take your fate in your own hand. The risk is that you will lose everything, what little money you have, but you would probably more likely look at the potential advantage.