What is foreign exchange risk?

What is foreign exchange risk?

Foreign Exchange Risk is the possibility that exchange rates will move against you when you have pending payment on transactions in another currency or other investment positions in foreign currencies or foreign assets which will be affected by Forex fluctuations.

Foreign Exchange Risk can also be called Forex risk, and it is the potential loss to an investor or institution when doing business in a foreign currency if the exchange rate swings unfavorably. Companies and countries take various measures to hedge against exchange rate risk, including holding reserves of other currencies and buying derivative contracts on various currency pairs.

There is also a risk of a political nature if a country like China or Japan, which hold trillions of dollars worth of USD in reserves, suddenly decided to divest a large amount of their reserves and effectively flood the market with dollars. This could significantly devalue the dollar and potentially send the US economy into a spiral.

The world economy inherently has a fair amount of risk associated with currency exchange rates. Changes in exchange rates have effects on international businesses known as foreign currency effects; the bottom line of a company operating in other countries will be heavily influenced by exchange rate fluctuations and risk.

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