Final answer:
Hedging is a financial strategy used to manage financial risk through transfer. It involves signing a financial contract to protect oneself against a risk from an investment, such as currency risk. This strategy helps protect against potential losses caused by fluctuations in exchange rates.
Step-by-step explanation:
Hedging is a way people manage financial risk through transfer. It involves using a financial transaction to protect oneself against a risk from an investment. For example, if someone is running a U.S. firm that is exporting to France and has signed a contract to receive euros in the future, they can hedge their currency risk by signing a financial contract that guarantees them a certain exchange rate. By doing so, they protect themselves from potential losses if the exchange rate fluctuates unfavorably.