What is a good way to hedge against systematic risks?

What is a good way to hedge against systematic risks?

• A. Futures contracts
• B. Government bonds
• C. Options
• D. Equity securities

Answer: (C)

Hedging against systematic risks, which are risks that affect the entire market or a significant segment of the market, can be effectively achieved through the use of options. Options allow investors to create strategies that can limit losses in declining markets. For example, purchasing put options provides the right to sell an asset at a specified price, thereby protecting against decreases in the asset's value. This method is particularly useful because it can be tailored to the investor's specific risk tolerance and market outlook. Options can help mitigate the potential impact of economic downturns, interest rate changes, or other market-wide phenomena by allowing investors to participate in potential upswings while having a built-in safety net against losses. In contrast, while futures contracts also serve as a hedging tool, they are often used for commodities or specific assets rather than systematic risks. Government bonds typically act as a safe haven but do not directly hedge against the market movements. Lastly, equity securities inherently carry systematic risk, as they are subject to market volatility. Therefore, the most effective and targeted option for hedging against such risks is indeed through the use of options.

Hedging against systematic risks, which are risks that affect the entire market or a significant segment of the market, can be effectively achieved through the use of options. Options allow investors to create strategies that can limit losses in declining markets. For example, purchasing put options provides the right to sell an asset at a specified price, thereby protecting against decreases in the asset's value.

This method is particularly useful because it can be tailored to the investor's specific risk tolerance and market outlook. Options can help mitigate the potential impact of economic downturns, interest rate changes, or other market-wide phenomena by allowing investors to participate in potential upswings while having a built-in safety net against losses.

In contrast, while futures contracts also serve as a hedging tool, they are often used for commodities or specific assets rather than systematic risks. Government bonds typically act as a safe haven but do not directly hedge against the market movements. Lastly, equity securities inherently carry systematic risk, as they are subject to market volatility. Therefore, the most effective and targeted option for hedging against such risks is indeed through the use of options.