Different Types of Currency Risk

Domestic markets would be a better type of investment for a retirement account. Because of the added stability, there is less of a chance the stocks could fall and hurt the retirement account. They also usually pay a more stabile dividend. However, domestic stocks are also used for short – term trading because it is easier to get access to the stock sooner.
Foreign markets allow the individual investor to invest in companies overseas. The main plus with these stocks is the usually have higher returns than domestic stocks. This is very attractive to everyone because everyone wants to make more money. These stocks are also allow protection in case an investor’s own country suffers a recession. The main problem with foreign stock is they are riskier than many domestic stocks. This is because foreign investors don’t usually get the same information as domestic investors just because they live in different countries. Also, the risk increased with less or with less democratic countries.
Foreign exchange risks arise from the fluctuation of foreign exchange rates. All participants in international economic activities are exposed to such Currency risks. In international financing, lenders and investors risk any devaluation of a foreign currency when they convert their foreign investment return back to their domestic Currency. Borrowers risk any appreciation of a foreign currency when they have to buy the foreign currency to repay their foreign lenders.
In international purchasing and trade, importers and exporters face the same foreign exchange valuation risks when they buy and sell foreign currencies to carry out their trade transactions.
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 investors 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, do the investors should consider revisiting the exchange at later date and determine if the currency risk is now within acceptable perimeters. Sometimes referred to as an exchange rate risk, 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 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.
• Translation Risk : Translation risk arises when the functional currency used in various transactions e.g. US Dollar (USD) or Great Britain Pound (GBP) is different from reporting currency, which in the Indian context is the Indian rupee (INR). Each currency may move in different directions. Functional currency may appreciates or depreciate against the reporting Currency.
• Transaction Risk : The other aspect of Currency risk is the transaction risk. The associated risk depends on the nature of the transaction. For example – whether the company is primarily in importer or an exporter of both. If the transaction currency is an appreciating one as against the reporting Currency, an importer will find his input costs rising. On the other hand on exporter would receive a higher income without having to raise prices. Such exposures also affects a company’s financial results by virtue of its effect on its foreign currency investment and borrowing transactions.
• Political Risk : Besides transaction and translation risks companies also face political risk and it is also referred to as country risks. A company transacting in a foreign country may finds its assets in that country frozen or even confiscated or it may find that the country has prohibited its currency from being convertible. Such an eventuality will prohibit the asset from being taken out of that country. Similarly, a country could increase the taxes that businesses are required to pay, thereby reducing the amount repatriable to home country. Another aspect of country risk is the legal jurisdiction to which business transaction are subjected.
• Interest Rate Risk : Although interest rate risk affects all the business including dealing solely in the home currency, foreign currency borrowers and lenders are exposed to the effects of changes in interest rate on foreign currency which in turn add to currency risk as the amount of interest payable/receivable in foreign currency fluctuates with currency movements.
• Economic Risk : Another aspect of Currency risk is the impact of exchange rates on future cash flow of the company.