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Answer: Hedge may be inappropriate if shareholders are focused on gross margins, and the cost of hedging would reduce margins to an unacceptable level
The question asks for the **EXCEPT** choice, meaning the option that is **not** a valid reason to avoid hedging. - **A** is valid: if shareholders are well diversified, they may not need the firm to hedge. - **B** is valid: if commodity price changes are passed through the supply chain, hedging may be unnecessary or even counterproductive. - **C** is valid: hedging can create career risk if management does not understand it. - **D** is the exception: if shareholders are focused on gross margins, that is generally a reason **to hedge**, because hedging can stabilize margins rather than avoid it. Therefore, **D** is the correct answer.
Author: Manit Arora
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Question 151.3 In theory, futures contracts can hedge commodity price risk. According to Hull, however, EACH of the following is a valid reason for a company to AVOID such a commodity price hedge EXCEPT for:
A
Hedge may be unnecessary if shareholders are well diversified
B
Hedge may be counterproductive if hedging is not the norm and commodity price changes ripple from raw material to wholesale and retail
C
Treasurer may incur career risk if senior management (and Board of Directors) does not under fully understand the nature of the hedge
D
Hedge may be inappropriate if shareholders are focused on gross margins, and the cost of hedging would reduce margins to an unacceptable level
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