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Foreign Exchange Risk Factors

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What foreign exchange risk factors should be considered while making investments in another currency?

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This solution provides detailed explanations for foreign exchange risk factors.

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Exchange Rate Risk
Organizations that invest internationally in today's increasingly global investment arena face the prospect of uncertainty in the returns after they convert the foreign gains back to their own currency. Unlike the past when most U.S. investors ignored international investing alternatives, investors today must recognize and understand exchange rate risk, which can be defined as the variability in returns on securities caused by currency fluctuations. Exchange rate risk is sometimes called currency risk.

Transaction exposure arises whenever a company is committed to a foreign-currency denominated transaction. Since the transaction will result in a future foreign currency cash inflow or outflow, any change in the exchange rate between the time the transaction is entered into and the time it is settled in cash will lead to a change in the dollar (HC) amount of the cash inflow or outflow. Protective measures to guard against transaction exposure involve entering into foreign currency transactions whose cash flows exactly offset the cash flows of the ...

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