Question

Tyke Wad inherited $10,000 from his favorite cousin fourth removed.

His friend, Flicker urged Tyke to use the money to make money.

Tyke’s other cousin, Tarot Kard read Investment for Dummies and has offered to serve as Tyke’s financial planner.

Tarot told Tyke “I feel strongly about these thee options that will allow you to be a big winner in this investment stuff. Even in the environment of today, I have three very good choices to suggest to you.”

1. Invest $10,000 In Wil O’ Wisp corporate secured bonds that pay 1%

2. Invest $10,000 in 100 shares of Wil O’ Wisp $100, 2%, cumulative preferred stock

3. Invest $10,000 in 15,000 shares Wil O’ Wisp common stock that has paid an annual dividend of one cent since the corporation began operations 7 years ago.

Assume that Tyke will select one of the three options.

Which of the three would you recommend and why?

Answer 1

The acceptance of one of the three methods depends upon the risk appetite.

We all know that more the risk, more the reward. The person taking more risk will be entitled to greater returns.

And all the options that are given give different percentage of returns and also bear different amount of risk.

The first option of secured bonds pays 1% on the amount of investment and as the name suggests they are secured. Hence, no loss will be borne by the person as secured bonds will be paid through property that is used for security in case of default. But also the return is less that is only 1% but it offers security.

The second option is cumulative preferred stock which offers greater return of 2% and is cumulative. Which means if any year the return is not offered it will get cumulated and will be given the following year. However, they are not secured but have preference over normal shareholders.

In case of default, they will be preferred over normal shareholders for payment and hence greater return for greater risk.

The third option is normal shareholders where they bear the risk but also get the profit. Any profit earned by company is liable to be given to shareholders after all liabilities gave been paid. Also the company has consistently given dividend of 1% for past seven years. Hence the company has good track record.

Thus it needs to be understood whether the person can bear risk for greater return. If not, the person should go for secured bonds. If the person can bear the risk then shares should be opted.

Personally, the person should go for combination of the given options to distribute risk and reward.

In my personal opinion, combination should be preferred. However, shares should be first choice if only one of the three is to be chosen. This will not only give returns but also give him chances of greater returns other than dividend.