What is Currency Hedging?
Currency hedging is an approach that is intended to manage the degree of risk that may be present when engaging in some type of foreign investment strategy. Essentially, the structure of a currency hedging process would attempt to compensate for any shifts in the relative value of the currency type utilized in the investment scheme. The hope is that by minimizing the exposure of the investor to unfavorable shifts in the money market, a reasonable return on the investment will be achieved even if the currency involved takes a fall. In general, any hedging strategy is understood to help insulate the investor from the occurrence of events that could threaten to cause a deal to lose money. When it comes to currency hedging, the idea is to convert or exchange the currency while the rate of exchange is favorable, and then make the investment with currency that is native to the country of origin where the investment is based. For example, rather than paying for shares of stock connected to a
Currency hedging is the activity carried out in order to eliminate the risks stemming from an undesired exposure to a foreign currency. For example, a US investor might want to take exposure to the Japanese stock market, but not to the currency risk related to unexpected movements in the USD/JPY exchange rate. He would then invest in the Japanese stock market and perform currency hedging by selling the Japanese Yen forward, in order to fix today tomorrow’s price of the Yen and eliminate the currency risk associated to his position in the Japanese stock market.
Many businesses, individuals and institutions minimize the effect of volatile exchange rates by hedging. Hedging is the practice of offsetting risk, often by purchasing one position to protect another position. For example, a company transacting business in both Euros and US Dollars may invest in both currencies to offset fluctuations in either direction. As another example, many investors recommend gold as an investment to protect against a falling US dollar. Recent gold prices are a testament to the popularity of this strategy.
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