Which statement accurately describes short selling?

Prepare for the BPA Banking and Finance Test. Engage with practice questions and detailed explanations. Ace your exam with confidence!

Short selling is a trading strategy that involves selling borrowed securities with the expectation of buying them back later at a lower price. This allows an investor to profit from a decline in the price of the asset. The process begins with the investor borrowing shares from a brokerage firm and selling them at the current market price. If the price of the stock subsequently falls, the investor can buy back the same number of shares at the lower price, return them to the lender, and pocket the difference as profit.

This method relies on the investor's assessment that the market is overvalued or that the specific security will decline in value. It's a risky strategy since if the price of the stock increases instead of decreases, the investor may face significant losses, as there is theoretically no limit to how high a security's price can rise.

The other choices do not accurately capture the essence of short selling. For instance, buying stocks at a high price with the expectation to sell at a lower price misrepresents the direction of the transaction and is contrary to the short selling strategy. Selling securities bought at a lower price with a guaranteed profit doesn’t align with the nature of short selling, which does not provide a guarantee of profit and involves borrowing shares. Finally, purchasing stocks for

Subscribe

Get the latest from Examzify

You can unsubscribe at any time. Read our privacy policy