Common Mistakes Made When Hedging Include: the Possibility of Having

question 6

Multiple Choice

Common mistakes made when hedging include: the possibility of having a natural hedge; liquidity risk; and base risk.Which of the following does NOT represent one of these three possible risks?

• A) Future contracts are negotiated as agreements between parties that are not anonymous. Therefore, there is a possibility that one of the parties may default before the contract is finalized.
• B) The hedge may not be necessary if the firm can effectively pass future cost increases on to their customers through higher prices .
• C) In the event that price changes during the life of the contract require an increased contribution to the margin account, this may be an unanticipated cost for the firm and, if not addressed, could result in a default in the position taken in the contract.
• D) Future contracts require the matching of the quantity and timing of future deliveries. If both parties cannot provide this matching, one party will be unable to completely hedge their future position.

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Definitions:

Extraordinary Items

Refers to rare and infrequent transactions that are outside the normal course of business, often excluded from regular income statement categories to provide a clearer view of ongoing operational performance.

Noncurrent Assets

Long-term assets not expected to convert into cash within one year, such as property, plant, and equipment, intangible assets, and long-term investments.

Investing Activities

Transactions and events that involve the purchase or sale of long-term assets and other investments not included in cash equivalents.

Operating Activities

Business actions that are directly related to the production and delivery of goods and services, which are fundamental to the company’s operations.