Question

1. Explain the following terms as concisely as possible with your own definition, example, and graph. Also, for each term, discuss real-world applications with respect to its importance, purpose, motivation, ete, if you found any. a. Speculation b. Hedging c. Arbitrage d. Risk (in Finance)

Answer 1

Speculation

Speculation can be defined as an activity to buy and sell stocks in hope of getting good returns without any evidence of concrete reasoning and a possible risk of losing the principal amount

Hedging

It is an activity carried out to mitigate risks with or without any expectation of profit. Example : If an American shoe company regularly imports rubber from Taiwan then to mitigate risk of fluctuations in the currency, they might use futures of rubber to mitigate their risk.

Arbitrage

Arbitrage is an activity of buying and selling goods, commodities, stocks simultaneously in different markets to gain from the price difference in the different markets. For Example, if a stock is sold is sold on NASDAQ at a higher price and simultaneously bought from NYSE at a lower price then it will give pure arbitrage and it is riskefree gain.

Risk

Risk is uncertainty of losing an investment. It can also be stated as a possible downside accepted by an investor for a possible return on investment.