What Is Currency Risk?

Currency risk is commonly referred to as exchange-rate risk. It arises from the change in price of one currency in relation to another. Investors or companies that 🙈have assets or business operations across national borders are exposed to cur🍬rency risk that may create unpredictable profits and losses.

Many multinational corporations and institutional investors such as hedge funds and mutual funds use forex, futures, options contracts🍒ꦛ, or other derivatives to hedge the risk.

Understanding Currency Risk

The possibility of 澳洲幸运5官方开奖结果体彩网:managing currency risk began to capture attention in the 1990s in response to the 1994 Latin American crisis. Many countries in that region held foreign debt that exceeded their earning power and ability to repay.

The 1997 Asian currency crisis that began with the financial collapse of the 澳洲幸运5官方开奖结果体彩网:Thai baht kept the focus on exchange-rate risk in the years that followed.

Currency risk can be reduced by hedging, which offsets currency fluctuations. If a U.S. investor holds stocks in Canada, the realized return is affected by both the change in stock prices and the change in the value of the Canadian dollar against the U.S. dollar. The investor breaks even minus associated trading costs if a 15% return on Canadian stocks is realized and the 澳洲幸运5官方开奖结果体彩网:Canadian dollar depreciates 15% against the U.S. dollar.

Examples of Currency Risk

U.S. investors can consider investing in countries that have strong rising currencies and 澳洲幸运5官方开奖结果体彩网:interest rates to reduce currency risk. They should review a country’s inflation, however, because high debt typically precedes inflation. This can result in a loss of economic confidence that can cause a country’s currency to fall. Rising currencies are associated with a low 澳洲幸运5官方开奖结果体彩网:debt-to-gross domestic product (GDP) ratio.

The 澳洲幸运5官方开奖结果体彩网:Swiss franc is an example of a currency that's likely to remaꦐin well-supported due to the country's stable political system and low debt-to-GDP ratio. The New Zealand dollar is likely to remain robust due to stable exports from its agriculture and dairy industry which may contribute to the possibility of interest rate rises.

Investing in bonds can expose investors to currency risk because bonds have smaller profits to offset losse🎶s caused by currency fluctuations. Currency fluctuations in a foreign bonওd index often double a bond’s return. U.S. investors can expect more consistent returns from U.S. dollar-denominated bonds because these instruments have lower currency risk.

Investing globally is a prudent strategy for mitigating currency risk because a portfolio that's diversified by geographic regions provides a hedge for fluctuating currencies. Investors might consider investing in countries that have their 澳洲幸运5官方开奖结果体彩网:currency pegged to the U.S. dollar, such as China. This isn't without risk, however, because centꦏral banks may adjust the pe🌜gging relationship. This would be likely to affect investment returns.

Special Considerations

Many 澳洲幸运5官方开奖结果体彩网:exchange-traded funds (ETFs) and 澳洲幸运5官方开奖结果体彩网:mutual funds are designed to reduce curre🔯ncy risk because they're hedged. This is typically accomplished by using forex, options, or futures. The rise in the U.S. dollar has prompted numerous currency-hedged funds that have been introduced for developed and emerging markets including Germany, Japan, and China. The downside of currency-hedged funds is that they can reduce gains and they're more expensive than funds that aren't cur🧸rency-hedged.

BlackRock's iShares offers a line of 澳洲幸运5官方开奖结果体彩网:currency-hedged ETFs as an altern✤ative to its less-expensive flagship internat💖ional funds. Investors began reducing their exposure to currency-hedged ETFs in response to a weakening U.S. dollar in 2016. The trend has continued and has led to the closures of several such funds.

The Bottom Line

Currency risk in international trade is the risk traders assume when t𒐪hey make transactions in foreign currency. Exchange rates tendও to fluctuate over time and businesses can lose value if they hold a weakening currency. Certain hedging strategies can help alleviate this risk.