What is a Currency Risk?

Malcolm Tatum

Currency risks represent the degree of potential that any given investment or adjustment to the business operations of a company could be impacted by some change in exchange rates. The exact nature of the currency risk could be considered to be very low and thus well worth the risk in light of the chance for a high return. At the same time, a currency risk that is considered to be somewhat high could be sufficient reason to hold off on making the investment or implementing the change to the business operation.

A currency risk illustrates the impact of a potential change in exchange rates.
A currency risk illustrates the impact of a potential change in exchange rates.

Sometimes referred to as an exchange rate risk, the currency risk often involves the task of converting one type of currency into another type of currency in order to engage in a given investment. For example, a company may be considering the purchase of a competitor that is based in and operates primarily in a different country. When this is the case, it may be necessary to convert the currency used for the purchase into the type of currency used in the country where the purchased corporation is physically located. The exchange rate involved in making the conversion may indicate that the time for the purchase is not right, and the acquisition should be delayed.

A currency risk can also impact investors as well. This is especially true for investors who routinely choose to dabble in investment opportunities that involve international components. Once again, the rate of exchange between one currency to another could indicate that the current strength of the base currency is such that the exchange will ultimately put the investor at a disadvantage. When this is the case, the investment should be delayed. However, exchange rates and other pertinent factors can and do change over time, so the investor should consider revisiting the exchange at a later date and determine if the currency risk is now within acceptable perimeters.

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The existence of a currency risk is inherent in many different types of investment and acquisition strategies. As long as the risk is considered acceptable to the investor, then the risk should be weighed against the potential return and possibly executed. However, if the currency risk is considered unacceptable, it is usually advisable to move on to other financial strategies in the short term, and take a second look at the deal when some factor has undergone some type of change.

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