What is foreign exchange risk?

Foreign exchange risk refers to the potential for loss that arises from fluctuations in currency exchange rates during international transactions. When businesses or investors engage in transactions that involve different currencies, any change in the value of those currencies can impact the final amount received or paid, leading to financial losses. This risk is particularly significant for companies that conduct transactions in multiple currencies, as they may experience variations in revenue or costs due to changes in exchange rates.

For example, if a company is based in the United States but sells products in Europe priced in euros, a decline in the value of the euro against the dollar can result in reduced profits when the company converts its euro income back to dollars. Understanding and managing this risk is crucial for organizations involved in international trade and investments, making it a key component of financial strategy.