Financial Risk Manager Part 1
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In risk management, the term 'hedging' is often used to describe a specific strategy aimed at protecting the value of an asset or portfolio against potential losses due to market fluctuations. Which of the following options most accurately captures the essence of this concept?
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A
Buying an asset to offset a decline in value of another asset.
B
Holding an asset that appreciates in value to offset the decrease in the value of another asset.
C
Selling a loss-making asset and replacing it with a profitable one.
D
Holding an offsetting position in an asset or portfolio whose value we expect to move in line with market changes.
Explanation:
Hedging entails any action taken to safeguard the value of an asset in the face of changing market prices. It's actually an attempt to "lock-in" the value of an asset. The investor protects their investment by holding assets that have a predetermined future price.
Option A is incorrect. Buying an asset to offset a decline in the value of another asset refers to diversification.
Option B is incorrect. Holding an asset that appreciates in value to offset the decrease in the value of another asset is also a diversification method.
Option C is incorrect. Selling a loss-making asset and replacing it with a profitable one is a form of Profit/Loss strategy.
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