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Currency Hedging

Currency hedging is a risk management strategy used by investors, businesses, and financial institutions to protect against potential losses from fluctuations in exchange rates. Hedging involves using financial instruments like forwards, futures, or options to lock in a specific exchange rate or mitigate the impact of adverse currency movements. Currency hedging is common in international trade and investment, where exchange rate volatility can significantly affect profits or returns.

Example

A U.S. company expects to receive payments in euros in six months. To protect against a potential decline in the euro’s value, the company enters into a forward contract to lock in the current exchange rate.

Key points

• Currency hedging protects against losses from exchange rate fluctuations.

• Common hedging instruments include forwards, futures, and options.

• Hedging is widely used in international trade and investment to stabilize returns.

Quick Answers to Curious Questions

Businesses use currency hedging to protect against exchange rate fluctuations that could negatively impact profits or cash flows from international transactions.

Common hedging instruments include forward contracts, currency futures, and currency options, which allow companies to lock in exchange rates or limit exposure to adverse movements.

Currency hedging reduces the risk of currency volatility affecting investment returns, particularly for investors in foreign assets or international markets.