The purpose of hedging with FRAs, IRGs, futures, and options is to:

The purpose of hedging with FRAs, IRGs, futures, and options is to:

• A. Guarantee profits
• B. Reduce exposure to adverse rate movements
• C. Eliminate all market risk
• D. Avoid any investment risk

Answer: (B)

Hedging with these instruments aims to reduce exposure to changes in interest rates. By taking offsetting positions in FRAs, IRGs, futures, or options, you create a buffer that limits how much your future cash flows are affected by adverse moves in rates. For example, locking in a borrowing rate with a forward-rate agreement means that if rates rise, the hedge helps offset the higher cost, and if rates fall, you don’t gain as much from the lower rate but you’ve reduced potential losses from rate spikes. Hedges don’t guarantee profits, and they don’t remove all market risk. The payoff depends on how well the hedge tracks your actual exposure, so there can be basis risk. There are also costs and potential opportunity costs if rates move in your favor but the hedge limits those gains. The key idea is that these tools reduce the likelihood of large losses due to interest-rate movements, rather than eliminating risk altogether.

Hedging with these instruments aims to reduce exposure to changes in interest rates. By taking offsetting positions in FRAs, IRGs, futures, or options, you create a buffer that limits how much your future cash flows are affected by adverse moves in rates. For example, locking in a borrowing rate with a forward-rate agreement means that if rates rise, the hedge helps offset the higher cost, and if rates fall, you don’t gain as much from the lower rate but you’ve reduced potential losses from rate spikes.

Hedges don’t guarantee profits, and they don’t remove all market risk. The payoff depends on how well the hedge tracks your actual exposure, so there can be basis risk. There are also costs and potential opportunity costs if rates move in your favor but the hedge limits those gains. The key idea is that these tools reduce the likelihood of large losses due to interest-rate movements, rather than eliminating risk altogether.