Currency risk, also known as foreign exchange risk or exchange-rate risk, is the possibility of financial loss that arises from unpredictable fluctuations in the value of one currency relative to another.

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This risk affects individuals, investors, and companies that engage in international transactions, hold assets, or conduct business operations across different countries.

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Currency risk can impact the real costs and revenues of imports, exports, foreign investments, and financial reporting, as changes in exchange rates can either increase or decrease the value of cash flows or assets when converted back to the domestic currency.

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Example of Currency Risk
Scenario:
A U.S.-based company agrees to purchase machinery from a German supplier for €500,000, with payment due in three months.

What Could Happen

• At the time of the agreement:
  The exchange rate is 1 EUR = 1.10 USD, so the cost in dollars is €500,000 × 1.10 = $550,000.
• Three months later:
  If the euro strengthens to 1 EUR = 1.20 USD, the cost becomes €500,000 × 1.20 = $600,000.

Impact

• The U.S. company now has to pay $50,000 more than originally expected, simply because the exchange rate changed.
• This additional cost is due to currency risk-the risk that the euro would appreciate against the dollar before the payment was made.

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