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Alternative investments include selling short

Radio Transcript, 2 minutes 45 seconds, for use during week of Dec. 17.

Description: Penny, Susan, and Ira discuss short sales and hedging

Announcer: Invest Wisely comes to you from Iowa State University Extension through a grant from the Investor Protection Trust, providing investor education on the web at: investorprotection.org.

Susan: My friends have been talking about alternative investments.  Can you help us understand what alternative investments are and whether they’re a fit for Ira or me?

Penny: There are many investments besides stocks, bonds, and mutual funds.  Many of these alternative investments are for advanced investors or for people who hire investment advisors.  And, many investors build large portfolios and never venture into these “alternative” investments.

Ira: What sorts of investments are we talking about?

Penny: Alternative investments can include short sales, real estate, and funds that use derivatives, among others.

Ira: I wouldn’t call either Susan or myself advanced investors.  Do we really need to know about alternative investments?

Penny: It’s worthwhile to have a basic understanding.  You may hear people talking about them or someone may urge you to invest and you’ll want to know what they are and why they may not be the choice for you.

Susan: That makes sense.  What, exactly, do we need to know?

Penny: As I mentioned there are different types.  Let’s start with short sales.

Ira: Is that what I have heard referred to as ‘selling short?’

Penny: Yes.  Short sales are sales of a stock with the expectation that it will decrease in value.  The investor borrows the stock from a broker to deliver to the buyer.  The investor assumes that he or she will be able to buy the stock back later at a lower price in order to return the borrowed shares to the broker. 

Susan: So the investor makes money when the price of a stock goes down rather than up.

Penny: Yes, but If, instead of decreasing in value, the stock rises, then the investor loses money.  And in short sales, there’s no upper limit to what an investor could lose.

Ira: So, even though there are advantages, selling short has big risks?

Penny: Yes.  There’s also something called hedging, or a covered short, which occurs when an investor actually owns the stock they are selling short.  In the case of hedging, an investor is trying to hold onto any gains without selling the underlying security.

Susan: Thank you, Penny.  This is helpful.

Penny: You’re welcome.  And remember, for more information visit the ISU Extension website at extension.iastate.edu and look for ‘Invest Wisely.’

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Updated December 19, 2007