The risk that movements in exchange rates will reduce the returns on foreign investments when translated back to the investor's home currency.
Deeper Explanation
A 20% return in a foreign market can be entirely eliminated by a 20% depreciation of that currency against the investor's home currency. Currency risk is often invisible to domestic investors who do not explicitly track it, but it is one of the most material sources of return variance in international portfolios. Hedging currency risk through forward contracts or currency futures eliminates the uncertainty but at a cost — the cost of carry between the two currencies. For investors in stable, developed-market currencies, currency hedging is often worthwhile for large international positions. For investors in emerging market currencies, the hedging cost can be prohibitively high — making currency risk an explicit, unhedgeable component of the international investment.
Continue Learning
Go deeper into the Macro school — frameworks, case studies, and decision systems.