Why are derivatives effective instruments for hedging?
A) They are negatively correlated with the firm's underlying risk.
B) There are so many of them.
C) They enhance the risk pool.
D) All of the above are correct.

Question

Quizplus · Accepted Answer

Derivatives are effective instruments for hedging because they can be designed to have a negative correlation with the underlying risk. For example, a futures contract to sell a commodity can offset the risk of a company that produces the commodity and is therefore exposed to price fluctuations. Choices B and C are incorrect as the number of derivatives or the risk pool they create do not necessarily make them effective for hedging.

Why Are Derivatives Effective Instruments for Hedging