Final answer:
The hedging principle of financing, also known as the principle of self-liquidating debt, is a strategy used by firms to protect themselves from currency risk. It involves using a financial contract to guarantee a certain exchange rate in the future, regardless of market fluctuations. Financial institutions and brokerage companies often handle the hedging process.
Step-by-step explanation:
The hedging principle of financing, also known as the principle of self-liquidating debt, is a strategy used by firms to protect themselves from movements in exchange rates. It involves using a financial transaction to offset the risk of currency fluctuations.
For example, if a U.S. firm is exporting to France and has signed a contract to deliver products receiving 1 million euros a year from now, they can hedge by signing a financial contract that guarantees a certain exchange rate one year from now.
This protects the firm from the risk of the euro declining in value against the U.S. dollar.
When parties want to hedge, they rely on financial institutions or brokerage companies to handle the hedging. These institutions may charge a fee or create a spread in the exchange rate to earn money.