Welcome to the Investors Trading Academy talking
glossary of financial terms and events. Our word of the day is “Currency Hedging”
In 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.
Hedging can be likened to an insurance policy that limits the impact of foreign exchange
risk. Hedging is often achieved through the use of derivatives such as options or futures.
Hedging is a way for a company to minimize or eliminate foreign exchange risk. Two common
hedges are forward contracts and options. A forward contract will lock in an exchange
rate today at which the currency transaction will occur at the future date.
Essentially, there are two options available to an investor: 1) be exposed to currency
fluctuations ; or 2) be currency hedged. The objective of currency hedging is to reduce
or eliminate the effects of foreign exchange movements over the life of the investment,
such that a Canadian investor receives a return solely based on the change in value of the
underlying assets, without the effect of changes in currency values.