Glossary term
Currency Risk
Currency risk is the chance that exchange-rate movements will reduce the value of foreign income, assets, or investments.
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What Is Currency Risk?
Currency risk is the chance that exchange-rate movements will reduce the value of foreign income, assets, or investments. It is also called exchange-rate risk. The risk appears whenever money is earned, spent, borrowed, invested, or valued in more than one currency.
For U.S. investors, currency risk often shows up when foreign stocks, bonds, funds, real estate, or business revenues are translated back into dollars. A strong foreign investment can still produce a weaker dollar return if the foreign currency falls.
Key Takeaways
- Currency risk comes from changes in exchange rates between two currencies.
- It affects international investments, foreign income, imports, exports, travel budgets, and overseas property.
- A foreign asset's local return and the currency return can move in different directions.
- Hedging can reduce currency risk, but it has costs and may remove upside from favorable currency moves.
How Exchange Rates Change Returns
Suppose a U.S. investor owns a European stock that rises 8% in euros. If the euro weakens against the dollar during the same period, the investor's dollar return may be lower than 8%, or even negative. If the euro strengthens, the dollar return may be higher than the local market return.
Currency risk can also affect businesses. An importer may face higher costs when the foreign currency strengthens. An exporter may become less competitive when the home currency strengthens. A multinational company may report translation gains or losses when foreign revenue is converted into the reporting currency.
Exposure | Currency Risk |
|---|---|
Foreign stocks | Local share return may be reduced or boosted after conversion. |
Foreign bonds | Coupon and principal payments depend on exchange rates. |
Imports and exports | Profit margins can change with currency moves. |
Foreign property | Sale value and expenses may shift in home-currency terms. |
Hedged Versus Unhedged Exposure
Some funds hedge currency exposure using forwards or other instruments. Hedging aims to reduce the effect of currency moves on returns. That can make the investment behave more like the local asset return, but hedging is not free and may not be perfect.
Unhedged exposure leaves the currency movement in the return. That can add volatility, but it can also diversify or help when the foreign currency strengthens. The right approach depends on the asset, time horizon, cost, and reason for holding the foreign exposure.
Currency risk is especially important when the spending need is in one currency and the asset is in another. A retiree planning U.S. expenses from foreign assets faces a different risk than a long-term investor using global funds for diversification.
The Bottom Line
Currency risk is the risk that exchange rates change the value of foreign income, costs, or investments. International exposure is not only about the asset itself. The currency translation can meaningfully change the final return.