What does hedge against inflation mean?

In economics, business and, particularly, trading of all
types, hedging refers to a method of reducing risks by taking action that tends to
counter the affects of future variations in environment, particularly in price of some
asset like shares, foreign exchange, or some commodity. In particular hedging refers to
practice prevalent in trade exchanges dealing in all kinds of assets to reduce the risk
of losses because of price fluctuations. It is important that while a hedging action
protects from possible losses due to future price fluctuations, simultaneously it also
eliminates possibilities of gains from corresponding price
variations.

The term inflation generally refers to general
level of price rise covering entire collection of goods and services used in the
economy, rather than price rise in some selected products. I am not aware of any
standard methods of hedging against such general inflation. I believe the question has
used the word inflation to mean price rise of specific assets rather than a general
increase in price levels in an economy.

Hedging against
price rise in future is required when it is known that some assets will need to be
purchased in future. For example, a company which has imported goods for which payment
will become due in foreign currency some time in future, say after 90 days from the date
of placing order. In this case the company will have to buy foreign exchange in the
required currency after 90 days. If the rate of this particular currency rises in
future, the company will need to pay extra money for purchasing the currency. The
company can reduce this risk by purchasing the required foreign currency in a futures
transaction where the purchase takes effect after 90 days at an agreed
rate.

If the actual rate of required currency increases
after 90 days the company will still be required to pay for the currency at the rate
agreed earlier. This way it will avoid the possible losses due to increase in price. But
the company will also loose the opportunity to benefit from the future price falls. Even
if the price of currency falls below the rate agreed, the company will have to buy the
currency at higher rate agreed earlier.