CFA Practice Question

There are 206 practice questions for this study session.

CFA Practice Question

Hedging is best defined as ______.

A. eliminating the risk associated with price changes
B. using financial assets that represent a claim on other assets
C. managing short-run financial exposure due to fundamental changes in the economy
D. managing long-term financial risk due to uncertain prices or interest rates
E. reducing the exposure to price or rate fluctuations
Correct Answer: E

User Contributed Comments 5

User Comment
viannie It's not A because hedging can only reduce but do not totally eliminate the risks associated with price fluctuation.
group The only logical choice is E since hedging does not eliminate the risk associated with the price changes it reduces the exposure of price or rate fluctuations
LloydBraun7 viannie, not true that hedging cannot eliminate market risk. Picture this: you buy an S&P 500 futures contract, let's say for $10 to keep it simple. Here you're exposing yourself to the risk that upon final settlement, the etf's (or however it settles) will be worth less than $10. Say a week after, that contract trades for $12. You go out and swap the same notional volume as your futures contract, in the OTC market. Specifically, you enter into a forward contract where you receive $12 per unit of volume and you pay the settlement price of the futures contract. Here, you've completely hedged your price risk and locked in a profit of $2 per unit.
johntan1979 Almost every textbook states "reduce risk". I don't think it is possible to completely remove risk. You'll be the world's most wanted man if you could do that.
To-be-CFA Hedging reduces, and speculating increases the risk.
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