- Hedging and speculating
Hedging means avoiding or covering foreign exchange risk. The need for hedging arises because exchange rates fluctuate continuously. Accordingly, individuals, companies and banks who expect to make or receive payments in foreign currencies at a future data face the risk of having to pay more or receiving less in domestic currency than they anticipated.
Such participants cover these risks in the forward market as it does not involve tying up there funds.
Speculation, on the other hand, refers to taking a foreign exchange risk or an uncovered position in the deliberate hope of making a profit. It is the opposite of hedging.