Machiraju (2007) states, “Hedging means securing oneself against loss from various risks that arises in international financial markets” (Machiraju 2007, p.94). Currency hedging is an activity associated with hedging and is carried out for the purpose of elimination of risks associated with foreign currency transactions. For instance, consider a US based manufacturing company enters into a contract with a German business partner at $1 million. The contract amount is expressed in euros and 1 euro equals 1 dollar on the date of the contract. Two years later, the value of the euro increases with respect to the dollar and hence it reached a level of 1 euro equals 2 dollars. It leads the manufacturing firm to suffer a foreign currency loss of $500,000. This loss can be avoided by the firm if it uses some currency hedging tactics. Capital hedging can save investors or firms from unfavorable shifts in the global money market. and it will also help them to achieve a reasonable amount of return on investment even if the value of the currency falls during the period of business contract. An idea connected with currency hedging is that converting or exchanging currency while the exchange rates are favorable, and then invest the money in the home currency of the respective nation where we want to make our investment (Sharpio, 2006, p.343).
There are numerous capital hedging methods have been formulated in order to protect a firm’s future cash flows from exchange rate fluctuations. The firm can adopt most appropriate technique after considering a number of factors such as firm’s strategies regarding hedge, present market situations and possibility of future exchange rate fluctuations. According to Collier and Ampomah (2007), currency hedging methods can be classified into two such as internal and external hedging techniques.