To create an easy-to-understand system of risk evaluation we have categorised risks according to school marks. In the first step, we have applied the German system with marks from 1 to 6, but our methodology can easily be adjusted to the systems of assigning marks in other countries.
We evaluate every investment with regard to four risk categories, awarding a school mark for every risk kind. Thus a specific risk profile is determined, which every investor can compare with his own perceptions of risk. In analogy to the school report, which summarizes the achievements and the shortcomings over a school year, we prepare a risk report that contains all the relevant risk characteristics of a stock, bond, fund or another financial instrument.
In detail we award the following risk marks:
1: very good (minimum risk) (comparable in the United Kingdom: A grade; France: 18-20; Spain 9-10, Italy & Netherlands: 10; Switzerland: 6)
2: good (practically no risk; increased risk only under very unlikely extreme circumstances) (comparable in the United Kingdom: B grade; France: 15-17.9; Spain 7-8, Italy & Netherlands: 8-9; Switzerland: 5)
3: adequate (normally low risk; under extreme circumstances increased risk) (comparable in the United Kingdom: C grade; France: 12-14.9; Spain 6, Italy & Netherlands: 7; Switzerland: 4)
4: sufficient (normally increased risk; under extreme circumstances highly increased risk) (comparable in the United Kingdom: D grade; France: 10-11.9; Spain 5, Italy & Netherlands: 6; Switzerland: 4)
5: deficient (high risk) (comparable in the United Kingdom: E grade; France: 6-9.9; Spain 3-4, Italy & Netherlands: 3-5; Switzerland: 2)
6: insufficient (irresponsibly high risk) (comparable in the United Kingdom: F grade; France: 0-5.9; Spain & Italy 0-2; & Netherlands: 1-2; Switzerland: 1)
Our assessment based on school marks is explained with the following two examples:
For a corporate bond with 10-year maturity and high credit rating from the issuer, this risk evaluation would arise:
- Default risk: Mark 2 => the payback of the bond is practically certain, under very extreme circumstances a low remaining risk exists
- Price risk: Mark 2 => only low price fluctuations are to be feared
- Liquidity risk: Mark 3 => in general there is a good trading volume, but not always
- Inflation risk: Mark 5 => over the long term a real depreciation is likely with accelerating inflation rates
With the shares of a leading technology company another picture appears:
- Default risk: Mark 4 => although the company is a market leader with a solid balance sheet, it could be endangered by a technological change
- Price risk: Mark 5 => short-term movements of prices depend strongly on the market sentiment; therefore, very high stock price fluctuations are to be expected
- Liquidity risk: Mark 1 => normally high stock market turnover
- Inflation risk: Mark 2 => sales prices develop regardless of the general price levels; low capital intensity avoids negative balance sheet effects from inflation
If you want to know more about our concept, please download the file: "Analysing Investment Risks"