Currency Risk
May 27th, 2010
What is currency risk?
Currency risk or currency exchange risk is the gain or loss from changes in the relative value of foreign currencies vs home currency. That is why currency risk is sometimes called foreign currency risk or currency exposure risk.
As with stock, bond or mutual fund trading, some investors love to trade currencies. If currency trading is your area, then you want to make sure you have currency risk management system in place to manage your currency exchange risk. Global risk factors on the currency market are not the same when you invest in US stocks using US currency.
Foreign Currency Risk example
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The currency exchange risk depends largely on the exchange rate of the foreign currency you are investing in relative to your home currency. You often hear that the dollar is weak today or the dollar is strong today. When the dollar is weak, the dollar is cheap to buy. Vice versa, when the dollar is strong, it is expensive to buy or invest in the dollars. If you don’t plan your currency investing properly, currency exchange risk will dwindle down all your investments. |
Exchange currency risks of a multinational corporation
When a company is a multinational corporation with businesses in many countries, foreign currency exchange risks become important factors affecting their profits. If the company has an office in Brazil, for example, the company needs to pay attention to the currency risk of Brazil and not necessarily foreign currency exchange risk of other foreign countries. If the corporation does not have an office in Japan, for example, the Japanese Yen will not become a currency risk for the corporation.
Foreign currency exchange risks for bonds and stocks
Consider foreign bonds that pay coupons in foreign currency or foreign stocks that pay dividends in foreign currency. The coupons you received or the dividends you received will largely depend on the currency exchange rates. If you are expecting $1,000 in dividends, you may be surprised to receive only $500 because of the currency exchange risk.
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