What is the process of hedging in currency exchange?

The correct answer involves engaging in transactions that protect against fluctuations in currency values. Hedging in currency exchange is a strategy used by individuals and businesses to reduce or mitigate the risk of adverse price movements in foreign exchange rates.

When participants hedge, they typically use financial instruments such as futures, options, and swaps to establish a position that offsets potential losses in their currency exposure. For instance, if a business expects to receive payments in a foreign currency but is worried that the value of that currency might decline before their payment is received, they can hedge against this risk by locking in the current exchange rate.

This proactive approach ensures that they have a certain level of financial security and predictability in their transactions, thereby managing risk effectively. Overall, hedging is a crucial practice in financial markets that helps stabilise cash flows in the face of currency volatility.