Currency hedging.
In plain English
Currency hedging offsets exchange rate exposure with a contract that gains when the currency move would otherwise cost you. A business with a foreign payment due can lock a forward rate today. A fund holding foreign stocks or bonds can sell currency forwards to strip the exchange rate out of its return. The cost is not a flat fee: it is driven by the interest rate difference between the two currencies, so hedging into a higher-rate currency usually earns a small pickup while hedging into a lower-rate one usually costs. A hedge removes the downside and the upside of the currency together.
01Why it matters
It explains why two funds holding the same foreign stocks can post different returns in the same year, and why hedged and unhedged versions of the same index fund sit side by side on a platform.
02The math, step by step
Say you hold 100,000 dollars of foreign stocks. The stocks rise 10 percent in local terms while the currency falls 6 percent. Unhedged you end near 103,400 dollars. Fully hedged you end nearer 110,000 dollars, minus the hedging cost. Reverse the currency move and the hedge is what costs you.
Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.
03What this is NOT
A hedge is not automatically safer. It removes currency risk and leaves the asset risk untouched. For a foreign stock holding, the share price swings are usually the larger source of movement, so hedging changes the mix of risk rather than shrinking risk overall.
04Receipts
Every figure on this page is sourced to a primary document. Tap to open the original.
Plain-English answers from our glossary. Receipts included. Never advice.
Educational tool. Answers come only from ClearMoneySchool's published glossary and are not advice. Why we never give advice