Currency hedging occurs when businesses agree to buy or sell a specific amount of foreign currency at a predetermined exchange rate on a future date to protect themselves from potential losses due to fluctuating exchange rates.
For example, a Canadian manufacturer that exports to the U.S. and receives USD payments enters into a forward contract to sell US$500,000 at a locked-in exchange rate of 1.36 three months from now, protecting against the risk that the Canadian dollar strengthens and reduces their revenue when converted.
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