💱 Currency Risk

See how exchange rate fluctuations affect international investments.

Introduction

Currency risk, also known as exchange rate risk, arises when the value of one currency changes relative to another.
It affects investors and businesses engaged in international trade or holding foreign assets.

Core Principles

  • Exchange Rate Volatility: Currency values fluctuate due to economic and political factors.
  • Transaction Risk: Costs of imports/exports change with currency movements.
  • Translation Risk: Foreign earnings lose value when converted back to domestic currency.

How It Works

  1. Monitor FX Markets: Track exchange rates and central bank policies.
  2. Hedge Exposure: Use forward contracts, options, or currency ETFs.
  3. Diversify Holdings: Spread investments across multiple currencies.

Advantages of Understanding Currency Risk

  • Helps protect international investments.
  • Guides hedging strategies for businesses and investors.
  • Encourages diversification across global markets.

Risks

  • Unpredictability: Currency markets are highly volatile.
  • Geopolitical Factors: Elections, wars, and trade policies impact exchange rates.
  • Cost of Hedging: Protection strategies reduce returns.

Famous Examples

  • Asian Financial Crisis (1997): Currency collapses triggered widespread economic turmoil.
  • Swiss Franc Shock (2015): Sudden removal of currency peg caused massive losses.

Conclusion

Currency risk is unavoidable in global investing.
By monitoring FX markets and using hedging tools, investors can reduce exposure to sudden swings.