Foreign exchange risk

Foreign exchange risk is the possibility of losing or gaining money when you exchange one currency for another. For example, if you're from the United States and want to buy something from England, you'll need to exchange U.S. dollars for British pounds. The exchange rate tells you how many British pounds you'll get for every U.S. dollar.

Exchange rates can change quickly and sometimes dramatically. This means that the value of the British pound can change a lot compared to the U.S. dollar. If you exchanged your U.S. dollars for British pounds when the exchange rate was high and then the value of the pound decreased, you might end up losing money when you exchange your pounds back into dollars.

Foreign exchange risk is a big concern for companies that do business in different countries. For example, if a U.S. company buys raw materials from a Japanese supplier and the exchange rate changes in favor of the yen, the company might end up paying more for the materials than it budgeted for. On the other hand, if the exchange rate changes in favor of the dollar, the company might pay less.

To minimize foreign exchange risk, companies might hedge by buying currency options or futures contracts. These financial products allow a company to lock in an exchange rate for a certain amount of time. This way, the company knows exactly how much it will pay for foreign goods or services, regardless of how the exchange rate changes later on.