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Answer: The company has no demonstrable skill in predicting the price of platinum yet is greatly exposed to it
## Correct answer: B The strongest rationale for hedging is that the firm is **highly exposed** to platinum prices but has **no edge in forecasting** those prices. Hedging is most compelling when: - the firm has large exposure to a risk factor, - the risk can materially affect cash flows or profits, and - management does not have superior ability to predict price movements. ### Why the other options are weaker - **A**: Shareholder diversification is not the best reason for the firm to hedge; shareholders can often diversify on their own. - **C**: Board understanding is not the key economic reason to hedge. - **D**: Peer behavior is not, by itself, a good risk-management justification. So **B** is the best reason to hedge platinum price risk.
Author: Manit Arora
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Q-710.2. An industrial manufacturer of vehicle emissions control devices is heavily dependent on platinum as an input, and the price of platinum has a significant impact on the company's cost of goods sold (COGS). Among the following justifications, if true, which is the best reason for the company to hedge the price risk of platinum?
A
The company's shareholders are well diversified
B
The company has no demonstrable skill in predicting the price of platinum yet is greatly exposed to it
C
Although the board does not understand hedging, most of the members will understand the better outcomes
D
Hedging is not the norm in the highly competitive platinum industry, where peer-versus-peer profit margins are scrutinized by analysts
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