What is the purpose of an FX hedge?

The purpose of an FX hedge is to eliminate foreign exchange risk. Businesses and investors engage in foreign exchange hedging to protect themselves against the potential adverse effects of currency fluctuations. When companies operate in multiple currencies, they face risks associated with changes in exchange rates that can impact their revenues, costs, and overall financial performance. By utilizing financial instruments such as forward contracts, options, or swaps, an entity can lock in exchange rates for future transactions, thereby reducing uncertainty and safeguarding against unfavorable market movements.

The primary focus of an FX hedge is risk reduction, not enhancement of the foreign exchange rates or encouraging speculation. While currency values might stabilize over time with stronger economic policies or interventions, hedging does not aim for indefinite stabilization of currency value or promote speculative trading; instead, it serves a strategic role in risk management for businesses operating with multiple currencies.