Final answer:
Yes, it is appropriate to hedge currency risks on foreign stocks to protect against exchange rate movements. For instance, a U.S. firm receiving euros for exports can use a financial contract to ensure a stable exchange rate, securing the value of its future payments despite market fluctuations.
Step-by-step explanation:
It is indeed appropriate to hedge currency risks on foreign stocks. When a firm is involved in international trade or investment, the value of foreign currency cash flows can fluctuate due to changes in exchange rates. For example, suppose a U.S. company has a contract to receive 1 million euros in one year from exports to France. The firm can hedge by entering into a financial contract that locks in a specific exchange rate for the euros it will receive, minimizing the impact of any adverse movements in the euro to U.S. dollar exchange rate. If the euro depreciates against the dollar by the time of payment, the firm is protected; however, if the euro appreciates, the firm might pay a hedging fee without reaping benefits, but it also avoids the risk of currency loss.
Financial institutions or brokerage companies typically facilitate hedging for firms, earning through fees or spread on the exchange rate. This service becomes critical as exchange rates can move significantly, influenced by market expectations and can be self-reinforcing. Hedging provides a way to mitigate risks associated with such volatility and protect the firm's financial interests.