Final answer:
Hedging is financially protecting against the risk of currency fluctuations, but can incur costs without benefit if exchange rates move favorably or never realize predicted adverse changes. Money market hedging is an alternative that involves borrowing and lending in foreign currency to lock in current exchange rates, often managed by financial institutions which take a fee or earn through exchange rate spreads.
Step-by-step explanation:
There are several arguments against hedging, despite it being a method used to manage risks associated with fluctuations in exchange rates for firms involved in international trade. One argument against hedging is the cost involved in entering hedging contracts, which might result in a fee without benefiting the firm if the anticipated adverse currency movements do not occur.
Another point is the possibility of losing out on potential gains should the currency move favorably instead of unfavorably. Money market hedging, on the other hand, is a technique where a company can manage exchange rate risk by borrowing and lending in the foreign currency. If a U.S. firm expects to receive 1 million euros a year from now, it could borrow the present value of that sum in euros currently, convert it to U.S. dollars at today's exchange rate, and use the future euro receivables to pay off the euro loan. This effectively locks in the current exchange rate.
Firms generally rely on financial institutions or brokerage companies to manage their hedging strategies. These services earn money either through a fee or by creating a spread in the exchange rate offered compared to the market rate. This ensures that firms have a guaranteed exchange rate, providing more predictability in their financial planning.