Payoff at Maturity on a Short Hedge _____ as prices of the Underlying Asset ____

Question

Payoff at Maturity on a Short Hedge _____ as prices of the Underlying Asset  ____

BlackTom AI · Accepted Answer

Question restatement: Payoff at Maturity on a Short Hedge _____ as prices of the Underlying Asset ____.

Option presented: Increases; Decreases.

Analysis of the option:
- Understanding the short hedge: A short hedge typically involves taking a short futures position to guard against a drop in the price of an underlying asset that you are concerned about (e.g., producers who might sell the asset later or investors shorting the asset). The payoff dynamics depend on how futures and the underlying move together, but the standard teaching is that the hedge payoff improves when the underlying price falls, because the futures position gains as prices fall (depending on the exact structure, but the conventional takeaway is that a short hedge gains when the underlying declines).
- Why this option can be correct: If the underlying asset’s price decreases, the payoff from the short hedge tends to increase, as the hedge is designed to profit from or offset adverse movements in the underlying price. In many textbook treatments, a short hedge’s payoff at maturity moves inversely with the underlying price, resulting in higher payoff when prices drop.
- Why the phrasing matters: The statement uses a direct cause-and-effect phrasing—payoff increases as underlying price decreases—which aligns with the general concept of a short hedge sharpening its payoff when the market moves downward.
- Consideration of alternative reasoning gaps: If one misremembers hedging mechanics, one might think payoff increases with rising prices; however, in a standard short hedge, a rise in the underlying would typically diminish the hedge’s payoff or create losses, since the futures would be unfavorable to a short hedger.
- Summary interpretation: The option asserts that a short hedge’s payoff increases when the underlying asset’s price falls. Given typical hedging logic, this connection is coherent, making the option plausible as the correct understanding of payoff dynamics in this setup when the underlying price declines.

Note: The provided input contains only one option without additional alternatives to compare. If other choices were present, a like-for-like evaluation would compare each statement against standard hedging mechanics to identify which statements correctly describe payoff behavior.

MGT232H5 S LEC0105 Quiz 7

Payoff at Maturity on a Short Hedge _ as prices of the Underlying Asset

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