What is hedging currency risk and name a common instrument?

What is hedging currency risk and name a common instrument?

• A. Reducing exposure to exchange rate movements; common instrument: forward contracts
• B. Increasing exposure to exchange rate movements; common instrument: forward contracts
• C. Hedging currency risk is illegal
• D. Hedging currency risk only applies to stocks

Answer: (A)

Hedging currency risk means reducing exposure to exchange rate movements so a business’s costs and revenues in foreign currencies stay more predictable. A common instrument is a forward contract, which locks in an exchange rate today for a specific future date. This ensures you know exactly how much foreign currency you’ll receive or owe, shielding you from adverse moves in the exchange rate. If the currency moves unfavorably, the forward offsets that impact; if it moves favorably, you still gain certainty and protect your budgeting. The idea here is to minimize uncertainty and potential losses from currency swings, not to increase risk. The other options don’t fit because increasing exposure would raise, not hedge, risk; hedging currency risk is legal; and hedging isn’t limited to stocks—it applies to any situation with foreign-currency exposure.

Hedging currency risk means reducing exposure to exchange rate movements so a business’s costs and revenues in foreign currencies stay more predictable. A common instrument is a forward contract, which locks in an exchange rate today for a specific future date. This ensures you know exactly how much foreign currency you’ll receive or owe, shielding you from adverse moves in the exchange rate. If the currency moves unfavorably, the forward offsets that impact; if it moves favorably, you still gain certainty and protect your budgeting.

The idea here is to minimize uncertainty and potential losses from currency swings, not to increase risk. The other options don’t fit because increasing exposure would raise, not hedge, risk; hedging currency risk is legal; and hedging isn’t limited to stocks—it applies to any situation with foreign-currency exposure.