Omega, Inc., a U. S.-based firm entered into an agreement with another party to exchange currency and execute the deal at a specific date in the future. What is Omega, Inc. engaging in when it insures itself against foreign exchange risk?

The answer is hedging.

Explanation:

Omega is engaging in hedging. Omega is locking the future spot price of the currency now. If this transaction happens over the counter, we call it forward contract. And if it happens at the exchange, we call it futures.

Hedging the foreign exchange risk is to reduce the risk of adverse depreciation of the currency in which Omega is expecting to receive.

Hedging is very important in risk management.

currency hedging

Explanation:

Currency hedging follows the same basic principle that hedging stocks with calls and puts, but only with foreign currencies. Its main purpose is to reduce currency exchange risks. Currency hedging consists basically of using derivative contracts (on forward rates) to reduce risks, it is like purchasing some type of insurance against currency devaluations. The extra costs associated with forward contracts are generally lower than the potential costs of severe devaluations.

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