2 brothers, Joe and Bob get equal dollar amounts of securities as a gift. Joe immediately sells his securities and deposits the money to a bank account. On the other hand, Bob keeps his securities positions and holds them in a brokerage account. After 5 years, Joe has $10,000 in his bank account, while Bob has $30,000 in his brokerage account. The $20,000 difference between the account balances is explained by:

(A) Duration

(B) Standard deviation

(C) Opportunity cost

(D) Reinvestment risk

The answer is (C) Opportunity cost

Explanation:

Opportunity cost is the value someone misses when choosing one option over another one. That is exactly what happened to Joe, he had two options with his securities: 1) Selling 2) Keeping them

When Joe chose to sell his securities and deposit the money into the back account, he missed on the opportunity to see his money grow. Bob was in a similar position and he kept his securities and just 5 years later, the securities were worth $30,000.

You can calculate opportunity cost by substracting the return of the chosen option from the return of the best foregone option. In this case:

OC = 30000-10000 = 20000

Joe missed on $20,000 because he sold his securities instead of keeping them for 5 years.