Hedge Strategy Flashcards
What is hedging in finance?
Hedging is a risk management strategy used to offset potential losses in investments by taking an opposite position in a related asset.
True or False: A long hedge involves buying a futures contract to protect against rising prices.
True
What is the primary purpose of a short hedge?
The primary purpose of a short hedge is to protect against falling prices by selling a futures contract.
Fill in the blank: A _____ position is taken when an investor expects the price of an asset to rise.
long
Fill in the blank: A _____ position is taken when an investor expects the price of an asset to fall.
short
What is basis risk?
Basis risk is the risk that the cash price and the futures price may not move in tandem, affecting the effectiveness of a hedge.
Multiple choice: Which of the following is a common hedging instrument? A) Stocks B) Bonds C) Options D) All of the above
D) All of the above
What does it mean to construct a hedge?
To construct a hedge means to create a position that will mitigate potential losses in an investment.
True or False: Hedging guarantees a profit.
False
What is a cross hedge?
A cross hedge is a hedging strategy that involves taking a position in a different but correlated asset to manage risk.
Fill in the blank: The effectiveness of a hedge is often measured by its _____ ratio.
hedge
What is the main disadvantage of hedging?
The main disadvantage of hedging is that it can limit potential profits in a favorable market movement.
Multiple choice: Which of the following is NOT a type of hedge? A) Long hedge B) Short hedge C) Dynamic hedge D) Static hedge
D) Static hedge
What role do derivatives play in hedging?
Derivatives are financial instruments whose value is derived from an underlying asset, used in hedging to manage risk.
True or False: Hedging is only used by institutional investors.
False
What is an example of a long hedge?
An example of a long hedge is a farmer locking in a price for their crop by buying futures contracts.
What is an example of a short hedge?
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.
Fill in the blank: A _____ hedge is typically used by producers who want to secure prices for their products.
long
What does the term ‘delta’ refer to in hedging?
Delta measures the sensitivity of an option’s price to a change in the price of the underlying asset.
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
A) Reduces all risk
What is the difference between a natural hedge and a financial hedge?
A natural hedge involves a business’s operational practices to reduce risk, while a financial hedge involves using financial instruments.
True or False: Hedging typically requires a significant upfront investment.
False
What is the purpose of using options in hedging strategies?
Options provide the right, but not the obligation, to buy or sell an asset at a predetermined price, allowing for flexibility in hedging.
Fill in the blank: A _____ is an agreement to buy or sell an asset at a future date for a price agreed upon today.
futures contract
What does it mean to ‘lock in’ a price?
To ‘lock in’ a price means to secure a specific price for a future transaction, reducing uncertainty.
