how to hedge against currency risk

By Kimberly Amadeo. US Economy Expert

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Definition: The word hedge can used as a noun or a verb. Whether it's a product you buy, or an action you take, it is done to minimize or offset financial risk. When you purchase a hedge, you are hedging.

A hedge is an investment that's made, not so much to take advantage of a situation, but to prevent or offset another potentially risky or uncontrollable situation. For example, gold can be bought as a direct investment

if you think the price will go up, either because the demand will increase or the supply will decline.

However, buying gold is a hedge if you want to protect yourself from the effects of inflation. That's because gold keeps its value when the dollar loses its. In other words, if the prices of most things you buy goes up, then so will the price of gold .

This is unlikely, because there is such a finite supply of gold, and the dollar's value is primarily based on credit, not cash. However, it wasn't too long ago that the world was on the gold standard. and most major forms of currency were backed by their value in gold. Gold's historical association as a form of money is the reason it's a good hedge against hyperinflation or a dollar collapse.

Source: useconomy.about.com

Category: Forex

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