Currency hedging is the practice of using financial instruments, such as forwards, futures, options, or swaps, to reduce or eliminate the risk of adverse currency movements on international investments or business operations. It allows traders and companies to lock in exchange rates and protect against potential losses from currency fluctuations. While hedging reduces risk, it also involves costs such as premiums, margin requirements, and the potential opportunity cost of missing favorable exchange rate moves.
Example
“A US company with significant revenue in Japanese yen uses currency hedging by purchasing USD/JPY forward contracts to lock in a favorable exchange rate, protecting their profits from potential yen depreciation.”