Foreign exchange risk, also known as currency risk, FX risk, or exchange-rate risk, is the risk of financial loss that arises from fluctuations in exchange rates between currencies.

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This risk affects businesses, investors, and individuals engaged in international transactions or holding assets denominated in foreign currencies. When exchange rates move unfavorably, the value of payments, receipts, investments, or financial statements can change, potentially resulting in unexpected losses.

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Example

A Canadian technology startup signs a contract to sell software to a client in Japan for ¥10,000,000, with payment due in three months. At the time of the agreement, the exchange rate is 1 Canadian dollar (CAD) = 100 Japanese yen (JPY), so the company expects to receive CAD 100,000.

However, by the time the payment is made, the Canadian dollar has strengthened, and the new exchange rate is 1 CAD = 110 JPY. When the startup converts the ¥10,000,000 payment, it now receives only CAD 90,909. This results in a loss of CAD 9,091 compared to the expected amount, simply due to the change in exchange rates.

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Foreign exchange risk is a fundamental concern for any entity involved in cross-border activities, as it can directly affect profitability, asset values, and financial stability.

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