Question

An investor is speculating on the decline in the value of a security and purchases put options on the stock. The news ends up being positive and it results in a rise in the value of the security and the subsequent loss of the entire investment in the put options. This loss is an example of:

A. Currency risk
B. Capital risk
C. Opportunity risk
D. Reinvestment risk

Answer 1

The complete loss that the investor faces due to an unfavorable rise in the stock's value, against the expectations of the put options, is termed as 'Capital risk'. It directly relates to the potential loss of the investment capital.

Step-by-step explanation:

An investor who purchases put options on a stock speculates that the stock's value will decline. However, if the stock value rises due to positive news, the investment in put options may result in a complete loss. This loss is categorized as Capital risk, which involves the potential for an investor to lose part or all of the invested capital due to the asset's value moving contrary to expectations.

Unlike currency risk, the loss is not due to changes in exchange rates, and unlike opportunity risk, it's not the cost of missing a better investment opportunity. Reinvestment risk, on the other hand, refers to the risk of not being able to reinvest capital at the same rate of return. Therefore, the answer to the question is 'Capital risk' (B).