Which of the following describes an eligible hedged instrument?

An eligible hedged instrument is defined as an item that is utilized specifically to mitigate or eliminate the risk exposure associated with a hedged item. This means that its primary function is to provide protection against the fluctuations in the value or cash flows of the hedged item, which might be influenced by market risks, currency variations, interest rates, or other factors.

For example, if a company expects to receive payment in a foreign currency, it may use a forward contract as a hedged instrument to lock in the exchange rate, thereby reducing the risk associated with currency fluctuations. The effectiveness of the hedge would be assessed based on how well the changes in value of the hedging instrument offset the changes in value of the hedged item.

Understanding that eligible hedged instruments are intended for risk reduction helps to clarify why other options are not appropriate. Using an instrument to increase exposure to market risks is fundamentally opposed to the concept of hedging, as hedging is designed to minimize, rather than increase, risk exposure. Similarly, while securing cash flows or investing in financial assets with fixed interest rates may have their benefits, these activities do not directly align with the core purpose of a hedging instrument, which is specifically to offset risk from another investment or asset.