C is the answer since there will be sharing of risk when you purchase an option. One of the feature of option is that the holder only has the right and not the obligation to exercise it, in case the situation is favorable to the farmer, he will choose not to exercise the option and in case that it will be unfavorable the farmer can exercise the option, thus, the risk will be transferred to the other party. Moreover, in the option, there is a two party involved, thus, there will be sharing of risk, unlike in the risk reduction strategy, only the farmer will bear the risks.
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Jerome Umlas
Sta. Mesa, Manila
Philippines
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Original Message:
Sent: 08-02-2022 10:23 PM
From: Yu-Ting Yang
Subject: Question - Risk Mitigation Strategies
This practice question is from IMA. I choose b. because my Wiley material says that option is classified as a risk reduction. Does anyone know why this answer is c?
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Question:
A rice farmer has decided to protect against possible price fluctuations at the time of harvest by purchasing some rice options. What type of risk response strategy has the rice farmer engaged in?
a. Avoidance.
b. Reduction.
c. Sharing.
d. Acceptance.
Correct answer c.
In a financial transaction, the purchasing of options to cover price movement fluctuations is considered a risk transfer or risk-sharing strategy.