Hedge

From Forexpedia

For traders and investors, a hedge is a combination of different positions that helps eliminate the risk that is inherent in any position. In creating a hedge, traders will take opposing positions in separate markets. While this could limit profits had a trader taken just a single position, it serves its purpose as an “insurance” against unexpected market moves.

Hedging is an integral part of international trade. Because different currencies are used in international trade, companies are exposed to potential risk in currency price fluctuations. To combat this, companies make use of different strategies like currency options, futures and forwards contracts. By utilizing such strategies, this helps limit potential losses that may occur should currencies prices change drastically in the future.

An example of this is when a Japanese company is paid in dollars but pays in yen for its production costs. The company could stand to lose should the dollar fall versus the yen. The company can “hedge” by entering a currency forward contract that will lock in the price at which the company can exchange its dollars for yen.