What is an Exchange Risk?

An exchange risk is the potential for losses that could result when there is a shift in the value of currencies issued by different countries. Sometimes referred to as foreign exchange risk, investors will look closely at how any shifts in the rate of exchange between key currencies will impact the value of different types of assets. Consideration of this factor is often relevant to the decision to buy or sell shares of stock, or how to go about planning and executing an effective currency exchange strategy.

Attention to the exchange risk tends to be more pronounced when it comes to currency trading. By watching closely to see the effect that various factors have on the value of a given country’s currency, it is possible to determine if a trade involving that currency would prove lucrative. For example, in the event of a political election, the new regime could be viewed as favorable, a situation that is likely to lead to currency appreciation. At the same time, if the change in leadership is viewed unfavorably, the opportunity for currency depreciation in comparison to other currencies is highly likely.

Other factors can also influence the degree of exchange risk associated with a given currency and how it trades in comparison to other currencies. Natural disasters that cripple the economic infrastructure of a nation tend to increase the amount of exchange risk present. A sudden increase in demand for the goods and services exported by a particular country may lower the risk, at least for a short period of time. Wars often have a direct impact on the degree of exchange risk associated with the currencies of various countries, although that impact may be positive or negative.

By correctly assessing the potential exchange risk with a given transaction, the investor is able to determine if the exchange is likely to result in earning a satisfactory return, or if a different trade would be a better option. Since the foreign exchange market is easily one of the fastest moving in the world, the process of evaluating various factors to determine the current level of risk is ongoing. What is an excellent and very lucrative trade in the morning could very well turn into a trade that produces a loss in the afternoon. For this reason, constant attention to factors that impact the degree of exchange risk is essential for both investors and the dealers who execute the exchange orders on behalf of their clients.