Financial Accounting and Reporting-CPA Practice Exam

Engaging in hedging with derivatives primarily serves the purpose of stabilizing earnings volatility. When traders utilize derivatives, such as options or futures contracts, they aim to manage exposure to fluctuations in asset prices, interest rates, or currency exchange rates. By hedging, traders can offset potential losses in their underlying investments with gains in their derivative positions.

This stabilization is crucial for businesses and investors who want to ensure predictable cash flows, secure profit margins, and minimize the impact of adverse market conditions. For example, a company that is concerned about the rising prices of raw materials may enter into a futures contract to lock in current prices, thus reducing uncertainty and stabilizing their cost structure.

The other options involve aims that are not aligned with the primary objective of hedging. While maximizing potential gains and speculating on future price movements may involve taking on more risk rather than minimizing it, enhancing liquidity risk does not align with the intended outcome of using derivatives for hedging purposes. The essence of hedging is to protect value rather than to increase exposure or risk.