SIE (Securities Industry Essentials) Practice Exam

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What is the primary purpose of hedging in investment?

Maximizing profit
Mitigating maximum potential loss
Eliminating all investment risk
Speculating on market trends

The correct answer is: Mitigating maximum potential loss

Hedging is a risk management strategy that involves making an investment with the goal of minimizing potential losses, rather than maximizing profits. This means that option A, which suggests maximizing profit is the primary purpose, is incorrect. Option C, which suggests eliminating all investment risk, is also incorrect as hedging does not completely eliminate risk but rather reduces it. Option D, which suggests speculating on market trends, is also incorrect as hedging is primarily used to protect against adverse market movements rather than trying to predict them. Therefore, B, mitigating maximum potential loss, is the most accurate and useful explanation for the primary purpose of hedging in investment.