# Risk class

In finance, risk class is the division of natural persons according to their personal risk attitudes into given risk profiles in the context of financial advice .

## General

Investors have different ideas about the risk content of their investments and, given the large number of financial products and financial instruments , need information in order to decide on the right type of investment. This decision is usually brought about with the help of investment advice . According to the rulings of the Federal Court of Justice, this advice from credit institutions must be “appropriate to the investor” and “appropriate to the property”. Then they have to research the level of knowledge of the customer about investment transactions of the intended type and his willingness to take risks as part of the “investor-friendly” advice ; the investment property recommended by banks must take these criteria into account (“property-specific” advice). The “investor-friendly” advice corresponds to a long tradition of case law of the BGH. As early as November 1961, he demanded that banks should orientate themselves on whether the intended investment business is intended to serve as a safe investment or whether it is speculative in nature. With this objective in mind, the recommended investment must be tailored to the client's personal circumstances, ie be “investor-friendly”. These obligations for correct and complete investment advice result from the advice contract concluded .

While the risk class categorizes the financial products , the investment class classifies the investors.

## Consulting contract

The advisory contract is a free-form banking contract that is regularly concluded when a counseling interview is started. The consulting contract is to be distinguished both from the mere information, which is  exhausted in a factual disclosure, as well as from the clarification , in which in addition to the factual disclosure, their explanation is added. The advice includes both a subjective self-assessment of the form of investment and - with regard to the personal needs of the investor - a recommendation that leads to a buy, sell or hold recommendation.

Essential standards for the advisory contract can be found in the WpHG , which provides for extensive behavioral obligations for investment services companies, for example in Section 63 (1) WpHG the duty to provide careful and conscientious advice based on expert knowledge and free of conflict of interests . According to Section 64 of the WpHG, all investment information, including advertising communications, must be honest, clear and not misleading. The information requirements of Section 64 of the WpHG in conjunction with Section 5 (2) of the WpDVerOV as well as the recording and retention requirements introduced in January 2010 in Section 83 (2) of the WpHG do not change the freedom of form. Since January 2018 the is private investors in accordance with § 64 para. 4 WpHG before completion of a securities order a suitability statement in writing to leave. In Section 31 (5) WpHG a. F. Finally, banks were required to obtain information from customers about their knowledge and experience in relation to transactions with certain types of financial instruments ( general financial literacy ) in order to be able to assess the appropriateness of the financial instruments for customers. This must be taken into account in the declaration of suitability.

The client's willingness to take risks in order to achieve the investment objective must be researched. With his investment decision, the investor takes on certain financial risks associated with the investment object , which he must assume as a risk taker. The degree of willingness to take risks varies between risk aversion (the investor takes no or only very low risks) to risk affinity (he takes very high risks). These risks can be classified using the risk class to which each investment property is assigned. Advice will lead to different results because the planned investment business can either serve as a safe investment or has a speculative character. “Risk advice” is therefore particularly important. The customer is to be educated about

In accordance with Section 13 (1) of the Financial Investment Brokerage Ordinance (FinVermV), investment brokering is obliged to provide the investor with information about the risks of the financial investment offered or requested by the investor in good time before the conclusion of a transaction. This information must be written in such a way that the investor can reasonably understand the nature and the risks of the financial investments and can make an investment decision on this basis. All information, including advertising communications, must be honest, clear and not misleading ( Section 14 (1) FinVermV).

## Risk classes

The banking industry had from Section 31 WpHG a. F. Risk classes derived, which were included in questionnaires. The risk appetite of customers can range between risk aversion , when all risk of loss is avoided, and risk appetite . Risk-averse customers look for safe forms of investment, those willing to take risks are happy to accept the risk of loss from speculative transactions. There are further risk grades between the two extreme risk scales, so that the following risk classes result, with which financial products appropriate to the risk class can be linked:

Risk class Risk type Financial product
A. no risk Sight deposits , time deposits , savings deposits , savings (cash) letters and bonds
B. only interest rate risk Endowment insurance , “risk-free” government bonds
C. Interest rate or exchange rate risk Option bonds , money market funds , pension funds (in euros)
D. Interest and rate risk Bonds , equity funds , other investment certificates , foreign currency bonds
E. Total loss possible Shares , alternative investments , alternative investment funds , credit funds , futures ,
participation certificates , hedge funds , high-yield bonds , catastrophe bonds , media funds ,
microfinance funds , warrants , ship funds , subordinated savings bonds , structured
financial products
, venture capital

Explanations:

• Interest rate risk is the risk of interest losses that occur if the market interest rate rises above the interest rate of a financial product and an interest rate adjustment is not planned.
• Price risk : Financial products with a stock exchange or market price are subject to the risk of fluctuations in value. The price risk is eliminated for bonds in euros if they are held in the portfolio until they mature .
• Total loss is the risk that the entire investment amount invested in a financial product will no longer flow back to the investor.

With class A, the investment objective is security and asset preservation, higher risk classes involve a greater risk of loss. There are different reasons for this, such as a higher probability of failure or a higher fluctuation range . In class B, higher return expectations are offset by appropriate risks, C shows an increased willingness to take risks and return expectations are above the capital market level, D combines high return expectations with a high willingness to take risks, in E risk readiness and return expectations are very high. If a financial product is denominated in a foreign currency , it is always assigned to risk class D or E.

For allocation to the above classes, bonds must be differentiated according to the creditworthiness of the bond debtor . Bonds with the highest credit rating belong to class B because they have an interest rate risk, bonds with the weakest credit rating ( high-yield bonds ) are classified as class E due to the risk of total loss.

The risk premium is directly related to an investor's attitude to risk. The following risk settings can therefore be assigned to the risk premium : ${\ displaystyle R}$

${\ displaystyle R = 0}$ risk neutral ,
${\ displaystyle R> 0}$ risk averse ,
${\ displaystyle R <0}$ risk taker .

Risk-neutral investors expect a return in the amount of the risk-free interest rate, because they do not demand a risk premium and assign a disuse to the risk . Risk-averse investors, on the other hand, prefer investments that pay a risk premium. In turn, risky investors even receive a risk premium from the counterparty . In 1970 William F. Sharpe presented a capital market line on which all efficient portfolios are located as risk-return combinations . The capital market line is defined as all possible combinations of the expected return on a portfolio and its financial risk . This line corresponds to the market equilibrium on which all risk-neutral investors find themselves. Risk-averse investors are located below the equilibrium line, risk-averse investors above it because they are ready to accept a higher risk - measured with the standard deviation - for a higher return expectation .

## Change of risk class

A customer does not have to permanently remain in the same risk class, but can change the risk class, for example as he gets older from a previously risk-averse attitude to the risk-averse class A. Conversely, increasing experience and knowledge can also lead to a change to riskier classes.

## Individual evidence

1. BGH, judgment of July 6, 1993, Az. XI ZR 12/93 = BGHZ 123, 126: "Bond judgment"
2. BGH, judgment of November 25, 1961, z: IVa ZR 286/80 = NJW 1982, 1095, 1096
3. Marc-Philippe Weller : The Dogmatics of the Investment Advisory Contract, in: ZBB 3/11, 2011, p. 193.
4. after Katrin Severidt: Marketing für Anlageberatung , 1997, p. 11.
5. Florian Bartholomae / Marcus Wiens, Game Theory: An application-oriented textbook , 2016, p. 11
6. Matthias Kräkel, Organization and Management , 2007, p. 70
7. Florian Bartholomae / Marcus Wiens, Game Theory: An application-oriented textbook , 2016, p. 11
8. ^ William F. Sharpe, Portfolio Theory and Capital Markets , 1970, p. 83
9. Rolf Brühl, Controlling: Basics of a success-oriented corporate management , 2016, p. 409