What does 'hedging' in risk management refer to?

Hedging in risk management refers to implementing strategies to offset potential losses in investments through financial instruments. This practice is designed to reduce the risk of adverse price movements in an asset. By using various financial instruments like options, futures, or other derivatives, investors can protect their portfolios against risks associated with market volatility, fluctuation in asset prices, or even interest rate changes.

For example, if an investor owns stock that they believe may decrease in value, they could purchase put options on that stock. This gives them the right to sell the stock at a predetermined price, thus limiting their potential losses if the stock's value does decrease. Hedging does not eliminate risk entirely; rather, it provides a way to manage and mitigate risk effectively while still allowing for participation in the market.

The other options focus on different investment tactics that do not necessarily align with the concept of hedging. Investing all assets in one market represents a high-risk strategy without protection against losses. Taking on more risk to gain higher returns is opposed to the principle of hedging, which aims to minimize risk. Abandoning unprofitable investments does not inherently involve a strategy to offset potential losses; instead, it is a reactive approach rather than a proactive risk management strategy.