What is a 'hedge' in financial terms?

A 'hedge' in financial terms refers to an investment strategy designed to reduce the risk of adverse price movements in an asset. It acts as a form of protection against potential losses that can arise from fluctuations in market prices. By using various financial instruments or market strategies, such as derivatives (options and futures), investors can mitigate the impact of volatility on their investments.

This risk management strategy is critical for investors and businesses, as it allows them to maintain their positions while minimizing potential negative effects from market uncertainties. For instance, an investor may hold shares of a stock and simultaneously purchase a put option to sell those shares at a predetermined price, thereby setting a 'floor' for their potential losses.

In contrast, the other options do not accurately describe the concept of a hedge. An investment made with no associated risk suggests a complete elimination of risk, which is not realistic in finance. A strategy to maximize potential gains focuses on profit rather than risk management. A loan taken out to invest in stocks does not address risk reduction; instead, it introduces additional financial risk due to leverage.