In very simple terms, currency hedging is the act of entering into a financial contract
in order to protect against unexpected, expected or anticipated changes in currency
exchange rates. Currency hedging is used by financial investors and businesses to
eliminate risks they encounter when conducting business internationally. Hedging
can be likened to an insurance policy that limits the impact of foreign exchange
Hedging can be accomplished by purchasing or booking different types of contracts
that are designed to achieve specific goals. These goals are based on the level
of risk the customer is exposed to and seeking protection from and allow the individual
to lock in future rates without affecting, to a great extent, their liquidity.
Hedging can be a very complicated enterprise. The various hedging mechanisms range
from basic to extremely intricate. The most prudent first steps, when considering
a hedging strategy, would be to take note of potential foreign exchange exposure
and, based on that, evaluate what goals need to be set and what actions need to
be taken in order to mitigate that risk.
Learn about Forward Contracts