What is the fundamental purpose of hedging?

Hedging is primarily employed as a risk management strategy aimed at mitigating potential financial losses. The fundamental purpose of hedging is to protect investments from adverse price movements in an asset. By using various financial instruments, such as options, futures, or swaps, investors can offset potential declines in the value of their assets. This approach allows individuals or institutions to maintain their positions in the market while reducing the risk of unfavorable changes in market conditions that could lead to significant financial setbacks.

While the objective of hedging is to minimize risks, it does not aim to eliminate all investment risks. Every investment carries some level of inherent risk, and hedging can only reduce the extent of that risk rather than remove it entirely. Other options presented may focus on aspects like diversification and maximizing returns, which are valid investment strategies but do not capture the essence of what hedging is fundamentally about. Therefore, emphasizing the mitigation of potential financial losses aligns best with the core purpose of hedging.