Capital Risk

A client asks what is meant by capital risk. The best description is the possibility that:

1. A.Interest rates rise and the market value of a bond falls before it matures.Wrong. That is interest rate risk, which describes price movement rather than the permanent loss of principal.
2. B.Income from an investment fails to keep pace with the general rate of inflation.Wrong. That is purchasing power risk, and it concerns what the return buys rather than whether it exists.
3. C.A security cannot be sold quickly without the seller accepting a lower price.Wrong. That is liquidity risk, which is about marketability rather than about the money disappearing.
4. D.The entire amount invested may be lost and never recovered at all.Correct. Capital risk is the exposure of invested principal to being lost outright.

Why: Capital risk is the plain possibility that money put into a security does not come back. It is present in any investment not backed by an unconditional promise from a creditworthy obligor, and it is why equity holders sit last in liquidation. The other risks named describe how a return may disappoint rather than whether the principal survives at all. An investor can face several of these at once, which is why they are treated as distinct categories rather than as degrees of one thing.

Capital risk is best understood as the risk that an investor:

1. A.Receives less interest income than expectedThat is closer to reinvestment or call risk; capital risk concerns principal.
2. B.Sees inflation erode the value of a fixed paymentThat is purchasing-power risk.
3. C.Loses some or all of the principal originally investedCorrect. Capital risk is the risk to invested principal itself.
4. D.Cannot sell an investment promptly at a fair priceThat is liquidity risk.

Why: Capital risk is the risk of losing some or all of the principal invested. It is the baseline risk in any non-guaranteed investment and is greatest in speculative and leveraged positions.