Currency hedging is protecting yourself against exchange rate fluctuations. If you are an Indian company earning revenue in dollars, a strengthening rupee reduces your earnings when converted back to INR. Currency hedging locks in an exchange rate, ensuring predictable cash flows regardless of what the market does.
Key tools: currency forwards (lock in a rate for a future date), currency options (right but not obligation to exchange at a set rate), and currency swaps (exchange cash flows in different currencies). Indian IT companies like Infosys and TCS hedge 50-70% of their dollar revenue to protect against rupee appreciation.
Hedging is not free — the cost of hedging is the premium you pay for certainty. A forward contract might cost 2-3% annually in India (reflecting the interest rate differential between INR and USD). Some companies choose not to hedge and take the currency risk — a bet that can pay off handsomely or cause significant losses.