What is hedging?

• A. A risk management strategy used in increasing marketing reach.
• B. An investment strategy to maximize short-term gains.
• C. A method to improve product quality.
• D. A risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities; reduces the risk of adverse price movements in an asset.

Answer: (D)

Hedging is a risk management strategy used to limit or offset the probability of loss from fluctuations in prices of commodities; it reduces the risk of adverse price movements in an asset. In practice, hedging uses instruments like futures, forwards, or options to create a counterbalancing position that moves opposite to the price of the underlying commodity. For example, a grain producer worried about prices dropping before harvest can sell futures contracts now to lock in a selling price, reducing exposure to price declines, while a processor might buy futures to stabilize input costs. The goal is to protect value or profit margins, not to speculate for quick gains. The other choices describe expanding marketing reach, chasing short-term gains, or improving product quality, which are not about mitigating price risk.