Used to minimize or eliminate the probability of profit loss by minimizing risk.

• A. Speculation
• B. Hedging
• C. Arbitrage
• D. Diversification

Answer: (B)

Hedging reduces risk by taking an offsetting position to protect against adverse price moves in an asset you’re exposed to. In agriculture, a producer might sell futures contracts on their crop to lock in a price. If market prices fall, the gains from the futures help offset the lower cash price, helping protect income. If prices rise, the cash crop income goes up but the futures loss offsets some of that gain, resulting in more stable overall income. This approach directly targets the risk of a price drop or rise in a specific exposure, reducing the chance of a profit loss. Note that hedging can limit upside potential and there is still some basis risk if cash and hedging prices don’t move perfectly together. Speculation looks to profit from price changes and adds risk, arbitrage exploits price differences for a near risk-free profit and isn’t about protecting ongoing exposure, and diversification spreads risk across many investments but doesn’t eliminate risk for a single position.