Which statement best describes currency hedging in international investing?

• A. It reduces currency risk but adds cost; returns can be affected by hedging choice
• B. It increases currency risk with no cost
• C. It guarantees higher returns
• D. It has no effect on risk or cost

Answer: (A)

Currency hedging in international investing is about controlling exchange rate risk when you hold assets priced in another currency. You can use tools like forwards, futures, or options to lock in a rate or cap potential losses, which reduces the volatility caused by currency moves. But hedging isn’t free—the costs of implementing the hedge, bid-ask spreads, and financing the position all shave into returns. The impact on actual performance also depends on which hedging instrument and settings you choose, since different hedges can capture or miss out on favorable currency moves. So the best description is that hedging lowers currency risk but adds costs, and the final return can be influenced by how the hedge is structured. The other statements misstate the trade-off: hedging does not increase risk with no cost, it does not guarantee higher returns, and it does change both risk and cost.