Hedge Strategy

Question 1

What is hedging in finance?

Answer 1

Hedging is a risk management strategy used to offset potential losses in investments by taking an opposite position in a related asset.

Question 2

True or False: A long hedge involves buying a futures contract to protect against rising prices.

Answer 2

True

Question 3

What is the primary purpose of a short hedge?

Answer 3

The primary purpose of a short hedge is to protect against falling prices by selling a futures contract.

Question 4

Fill in the blank: A _____ position is taken when an investor expects the price of an asset to rise.

Answer 4

long

Question 5

Fill in the blank: A _____ position is taken when an investor expects the price of an asset to fall.

Answer 5

short

Question 6

What is basis risk?

Answer 6

Basis risk is the risk that the cash price and the futures price may not move in tandem, affecting the effectiveness of a hedge.

Question 7

Multiple choice: Which of the following is a common hedging instrument? A) Stocks B) Bonds C) Options D) All of the above

Answer 7

D) All of the above

Question 8

What does it mean to construct a hedge?

Answer 8

To construct a hedge means to create a position that will mitigate potential losses in an investment.

Question 9

True or False: Hedging guarantees a profit.

Answer 9

False

Question 10

What is a cross hedge?

Answer 10

A cross hedge is a hedging strategy that involves taking a position in a different but correlated asset to manage risk.

Question 11

Fill in the blank: The effectiveness of a hedge is often measured by its _____ ratio.

Answer 11

hedge

Question 12

What is the main disadvantage of hedging?

Answer 12

The main disadvantage of hedging is that it can limit potential profits in a favorable market movement.

Question 13

Multiple choice: Which of the following is NOT a type of hedge? A) Long hedge B) Short hedge C) Dynamic hedge D) Static hedge

Answer 13

D) Static hedge

Question 14

What role do derivatives play in hedging?

Answer 14

Derivatives are financial instruments whose value is derived from an underlying asset, used in hedging to manage risk.

Question 15

True or False: Hedging is only used by institutional investors.

Answer 15

False

Question 16

What is an example of a long hedge?

Answer 16

An example of a long hedge is a farmer locking in a price for their crop by buying futures contracts.

Question 17

What is an example of a short hedge?

Answer 17

An example of a short hedge is a company selling futures contracts to protect against potential declines in the price of a commodity it sells.

Question 18

Fill in the blank: A _____ hedge is typically used by producers who want to secure prices for their products.

Answer 18

long

Question 19

What does the term ‘delta’ refer to in hedging?

Answer 19

Delta measures the sensitivity of an option’s price to a change in the price of the underlying asset.

Question 20

Multiple choice: Which of the following best describes a perfect hedge? A) Reduces all risk B) Reduces some risk C) Increases risk D) None of the above

Answer 20

A) Reduces all risk

Question 21

What is the difference between a natural hedge and a financial hedge?

Answer 21

A natural hedge involves a business’s operational practices to reduce risk, while a financial hedge involves using financial instruments.

Question 22

True or False: Hedging typically requires a significant upfront investment.

Answer 22

False

Question 23

What is the purpose of using options in hedging strategies?

Answer 23

Options provide the right, but not the obligation, to buy or sell an asset at a predetermined price, allowing for flexibility in hedging.

Question 24

Fill in the blank: A _____ is an agreement to buy or sell an asset at a future date for a price agreed upon today.

Answer 24

futures contract

Question 25

What does it mean to ‘lock in’ a price?

Answer 25

To ‘lock in’ a price means to secure a specific price for a future transaction, reducing uncertainty.