Question

Write up to a one page, typed (single spacing is fine) essay on the following topic:

When might an investor want to short sell a stock? How is this done? Is this part of a "standard" portfolio? Does it increase portfolio risk?

Answer 1

An investor might want to short sell a stock when he thinks that the price of stock will fall in future and he will be able to make profits by selling it back to the lender at a lower price.This is done by borrowing the stock to from a particular investor at an interest rate for which you think whose price will fall in future and selling the stock now in spot market. After a particular time, if the price of stock falls, the investors buys it from the spot market and delivers back to the lender with rate of interest making profit. Yes, this is part of a standard portfolio as it is done on normal stocks. It increases the portfolio risk because the loss potential is unlimited if the price of stock rises in future to infinity. Also, contrasting with normal equity shares the risk is limited to the invested amount if the company goes bankrupt.

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