A derivatives contract:
A) increases the risk of both the hedger and speculator.
B) increases the risk of the hedger and decreases the risk of the speculator.
C) reduces the risk of the hedger and increases the risk of the speculator.
D) reduces risk in both cases.

Question

Quizplus · Accepted Answer

A derivatives contract is a financial instrument that allows parties to manage their financial risks. A hedger in this case is an entity that wants to reduce its existing risk exposure to a certain financial asset or instrument. By buying or selling a derivative contract, the hedger is able to reduce its risk exposure. However, a speculator is an entity that enters the market with the intention of making a profit from price changes in the underlying asset. By buying or selling a derivative contract, the speculator increases their risk exposure to fluctuations in the value of the underlying asset. Therefore, a derivatives contract reduces the risk of the hedger and increases the risk of the speculator.

A Derivatives Contract