Which of the following statements is true?
A)Over-hedging will lead to a significant reduction in risk, but also in returns.
B)In terms of risk and return, there is a linear relationship between an unhedged, a selectively hedged, a fully hedged and an over-hedged position.
C)It is not possible to over-hedge a position.
D)Over-hedging will lead to a significant reduction in risk, but also in returns, in terms of risk and return, there is a linear relationship between an unhedged, a selectively hedged, a fully hedged and an over-hedged position and it is not possible to over-hedge a position.

Question

Quizplus · Accepted Answer

Over-hedging refers to the practice of using hedging strategies to protect against more risk than is actually present in the portfolio. While this can indeed reduce risk significantly, it can also lead to a reduction in potential returns because the investor is essentially limiting their exposure to positive market movements as well. The other statements are incorrect: it is possible to over-hedge a position, and the relationship between risk and return across different hedging strategies (unhedged, selectively hedged, fully hedged, over-hedged) is not necessarily linear due to the complexities of market dynamics and the cost of hedging strategies.

Which of the Following Statements Is True