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What does hedging in financial terms aim to achieve?

  1. Increase the potential for losses

  2. Offset the risk associated with one asset by holding another

  3. Completely eliminate all types of risks

  4. Invest solely in high-risk assets

The correct answer is: Offset the risk associated with one asset by holding another

Hedging in financial terms is primarily aimed at minimizing or offsetting the risk associated with the fluctuations in the value of an asset. By holding another asset that has the potential to behave in the opposite manner, investors can mitigate potential losses or stabilize cash flow. This strategy is essential in various markets, including currency, commodities, and securities. For instance, if an investor holds a stock that they believe may decrease in value, they might buy a put option on that stock, which would increase in value if the stock does indeed decline. Thus, hedging does not seek to eliminate risk entirely, but rather to reduce the negative impact of risk on an investment portfolio. The other options present misunderstandings of the hedging strategy. The notion of increasing potential losses does not align with the purpose of hedging, which is to manage risk. Completely eliminating all types of risks is unrealistic, as every investment carries some level of risk. Finally, investing solely in high-risk assets directly contradicts the defensive nature of hedging, which focuses on protecting against adverse movements in asset values rather than seeking maximum exposure to risk.