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What is currency risk?

What is currency risk?

Countries, investors, and international businesses have to frequently assess currency risk, which is the chance that exchange rates will change unfavorably at inopportune times.

An investment in a foreign security or company, or income payments coming from foreign sources, can be at risk for exchange rate changes. If an investor or company has financial interests which are based in another currency, or if the investor engages in Forex trading, currency risk looms over the future value of the holdings, on top of any typical market risk.

It adds another layer of uncertainty to the ultimate future value of any asset which is either held in another currency or which hinges in some way on the value of foreign currencies. To hedge against currency risk, forwards or futures, which are both contracts which lock in an exchange rate for a currency at a future time, or derivatives based on these, can be used.

The futures market is liquid and the contracts are transferable to other investors, so most investors and institutions will use these more often than forward contracts. Futures and other derivative securities trade on the international Forex market.

Keywords: forward contract, futures market, forex market, currency risk,