What is Currency Risk?
It is a form of risk associated with the change in the price of one currency against another. If a company or investor makes an investment in assets and business operation across national borders, then they face currency risk if their positions are not hedged. It is also known as exchange rate risk.
Explanation of Currency Risk
For instance, if an investor is in America and he has made an investment in stocks in Canada, the return he/she will receive after realization will be affected by both the change in the price of the stock and change in the value of the Canadian dollar against the U.S. Dollar. Similarly, if an investor realizes the return of 10% in the Canadian stock and Canadian dollar also depreciates with the same rate against the U.S. dollar, then there will be no gain.
The currency risk is very important to understand because the exchange rates of foreign currency may change drastically. Despite how effectively the investment strategy is made, it affects the total return on the investment made by the investor.