What is the purpose of hedging in finance?

Hedging in finance serves as a strategy specifically aimed at mitigating potential losses that may arise from adverse price movements in assets or investments. By employing various financial instruments, such as options, futures, or other derivatives, investors can protect themselves against fluctuations in market conditions that could negatively impact their overall returns.

This protective measure allows investors to limit their exposure to risks, ensuring that they can maintain a level of stability in their investment portfolio. For instance, if an investor holds a stock and is concerned about potential declines in its value, they might purchase a put option, which gives them the right to sell the stock at a predetermined price, thus securing their investment against loss.

The other options do not accurately capture the essence of hedging. It does not guarantee profits on all investments, nor does it create risk; rather, it addresses existing risks. Additionally, while hedging can aid in decision-making by providing clarity on potential outcomes, its primary purpose is not to simplify financial decision-making but to serve as a risk management tool.