Socrates Motor Co. has a defined-benefit pension plan for its employees. To fund the plan, the company makes periodic contributions to a stock investment fund. If the stock market declines significantly, the company would have to make additional contributions to make up for lost revenue. The company could hedge its risk of a market downturn by periodically purchasing put options on the stock market.

Question

Quizplus · Accepted Answer

By purchasing put options on the stock market, Socrates Motor Co. could protect itself against losses in the value of its stock investment fund if the market declines significantly. This would allow the company to fulfill its pension obligations without having to make additional contributions out of pocket.