Which term describes a strategy to reduce risk by taking offsetting positions in investments?

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

Answer: (B)

Hedging is a risk-management approach that reduces potential losses by creating offsetting positions against an existing exposure. By arranging a hedge, you lock in a price or limit a downside, so if one investment moves unfavorably, the offsetting position helps absorb some of that loss. For example, if you own shares and worry about a short-term decline, you might buy a put option or sell futures on the same stock or index. If prices fall, the gains from the hedge offset part of the drop in the stock’s value. Similarly, using interest-rate swaps can shield you from rising or falling borrowing costs. The essential idea is protection: the hedge is designed to reduce risk, even though it may also cap some upside. In contrast, diversification spreads risk across many assets without offsetting specific exposures, arbitrage looks for price differences to exploit, and speculation seeks to profit from price movements without protection.