Imagine buying products from another foreign market and having to first buy their currency in the amount needed to make the purchase. Considering currency fluctuates up and down just as stocks do at a stock market, investors are now taking advantage of currency hedging to lock in a set currency exchange rate. This paper will discuss what currency hedging is, when to use currency hedging and why it may benefit transactions across foreign nations. To begin explaining what currency hedging is, first one needs to explain a quick example of currency exchange rates and how often they fluctuate. The chart below represents how much 1USD is valued compared to the Columbian peso (Trading Economics, 2012). When looking at the chart, understand it represents how many pesos it takes to buy 1USD. The Columbian peso can also be called COP (Trading Economics, 2012). Please note that in January 2012 it took around 1940 peso’s to buy 1USD. Then one month later in February 2012, it took around 1760 pesos to buy 1USD. The objective of preserving an investor’s capitol is to buy and sell when the rates would be most beneficial. For example, if an investor had 200,000,000COP and wanted to convert the currency to USD in January 2012, he would be able to buy 103,093USD. However, in February 2012 he would be able to buy 113,636USD with the same amount of pesos. By holding his transaction until the rates were cheaper for him to buy in February, he would gain 10,543USD or 9% more in just one month. On the flip side, if an investor wanted to buy COP with USD, it would be more beneficial to purchase COP in January 2012 as he will be able to purchase more pesos with his dollar rather than February when he will get less pesos for his buck. Now that the concept of foreign currency exchange rates have been established and explained, hedging is the next terminology to explain. Hedging can be viewed...
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