Foreign exchange risk and how it can affect investments made in international markets?
Foreign exchange risk refers to the losses that an international financial transaction may incur due to currency fluctuations.
Also known as currency risk, FX risk and exchange-rate risk.
It describes the possibility that an investment’s value may decrease due to changes in the relative value of the involved currencies.
Investors may experience jurisdiction risk in the form of foreign exchange risk.
Any appreciation/depreciation of the base currency or the depreciation/appreciation of the denominated currency will affect the cash flows emanating from that transaction.
Foreign exchange risk can also affect investors, who trade in international markets, and businesses engaged in the import/export of products or services to multiple countries.
The proceeds of a closed trade, whether it is a profit or loss, will be denominated in the foreign currency and will need to be converted back to the investor's base currency.
Fluctuations in the exchange rate could adversely affect this conversion resulting in a lower-than-expected amount.
An import/export business exposes itself to foreign exchange risk by having account payables and receivables affected by currency exchange rates.
This risk originates when a contract between two parties specifies exact prices for goods or services, as well as delivery dates.
If a currency’s value fluctuates between when the contract is signed and the delivery date, it could cause a loss for one of the parties.
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