Speculative risks: Price uncertainty with possible gains and losses
What is a speculative risk?
Speculative risk is a risk category that ends up in either a gain or loss if undertaken. If we put it that way, isn’t it like any other type of risk? What sets speculative risk apart from the others is the chance that the investment’s value will never appreciate. Investors make these speculative risks out of their own will. They have thought about it, and it was not a result of an unprecedented situation. Speculative risks are not pure risks because, as we’ve said, two things might happen. They can always end up giving you a massive gain since they can also give you an enormous loss. Pure risks are ones that only have chances of losses and not gains.
So, come to think of it, every investment poses speculative risks, and it does not have to be noticeable. It can be just a minimal degree. Investors can never be 100% sure about their investments. No one can ever be sure if they are going to be a success or failure. While we cannot eliminate risks, they can be lessened or hedged. Let us say that we have an options contract as our asset. It has different risks that include speculative risks. It is possible to hedge those.
Speculative investments and risks
Since we are talking about speculative risks, we might as well speak about speculative investments too. At first sight, these investments do not look like they are strong enough. They also do not immediately look like they are sustainable business models. Some investors are optimistic enough to think that the price may rise for several reasons. A security may show massive risks, but it also looks promising enough. For instance, the investor may believe in specific penny stocks or new market stocks to do well in the future.
One investment may be more speculative than the others. Let us look at a government bond and a junk bond. Which among the two do you think has a lesser speculative risk? Government bonds generally have lower risks of default. Hence, they should have lesser speculative risks. The more the speculative risk, the more profits and returns that you might get. Who would want to have more risks with lesser benefits, right?
Speculative risks can either end up in losses or gains. However, it is totally up to the investor to take that risk or not. If he decides to take that speculative risk, it is hard to tell the exact amount of loss or gain. However, there are factors to make an estimate. For instance, we can use company history and market trends during a stock purchase.
We have mentioned pure risks.
When we were starting the topic, we mentioned that speculative risks are not pure risks. Pure risks end up with nothing but loss. No one would voluntarily take these risks. However, there are some situations when the investor has no choice but to take a pure risk. They are typically used when assessing insurance needs. Let us say that you accidentally bumped and damaged another car. This situation ends up with nothing but losses. Hence, it is a pure risk.
Ending with an example
Financial investments like stock purchases most likely involve speculative risks. The value may go or down, which may lead to a gain or a loss, respectively. Some people may assume, but there is no guarantee about the outcome. Let us say that you got a call option. You are aware of the risk of losing the premium paid once the contract expires without a worth. However, you also know that you can gain in the long run. After all, nobody can exactly tell the future.