What is a foreign exchange hedge?

A method used by businesses and investors to reduce or eliminate the risk of unwanted currency fluctuations when carrying out transactions in foreign currencies.

Where have you heard about foreign exchange hedging?

If you're investing in overseas shares, you may be given the option of hedged share classes to limit your currency risk. Foreign exchange hedging is also common in international business as it provides businesses with a level of certainty about future transactions.

What you need to know about a foreign exchange hedge.

Currency markets can be extremely volatile. If you’re investing in overseas shares then any gains in your investment could be wiped out by a shift in the exchange rate. For businesses who import or export goods, an adverse move in the exchange rate could have a big impact on profit margins.

A foreign exchange hedge helps remove this risk by cancelling out the impact of currency exchange fluctuations on an investment. For example, businesses may enter into a forward contract where an exchange rate is fixed for a currency transaction at a future date.

This helps remove downside risk, but means you won’t be able to take advantage of any positive shifts in the exchange rate that could increase the return you get on your investment.

Find out more about foreign exchange hedging.

A forward contract is one type of foreign exchange hedge. Find out more about forward contracts and how they’re used in our definition.