When an organization purchases a derivative contract in the stock market to limit the potential loss in the value of a security, the organization is applying which of the following risk management…

Question

Options

• AAvoiding the risk altogether.
• BTransferring the risk.
• CIntroducing a control feature.
• DAccepting the risk.

• A
  14% (4)
• B
  79% (23)
• C
  3% (1)
• D
  3% (1)

Explanation

Purchasing a derivative (such as an option or futures contract) to offset potential losses transfers the financial risk to the counterparty in that contract - the organization no longer bears the full downside alone, which is the essence of risk transfer (B). Option A (avoiding) would mean not holding the security at all; buying a derivative while keeping the position is the opposite of avoidance. Option C (control feature) refers to internal processes or safeguards within operations, not a market instrument. Option D (accepting) means consciously absorbing the loss with no protective action, whereas hedging with a derivative is an active mitigation step.

Memory tip: Think of derivatives as "passing the hot potato" - you still hold the investment, but you've handed the heat (loss exposure) to someone else. Passing = transferring.

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