What it is:
Currency risk, also called currency.or , is the risk that changes in the relative value of certain currencies reduce the value of denominated in a foreign
How it works (Example):
Currency risk may be the single biggest risk for holders of principal payments in a foreign . For example, assume XYZ Company is a Canadian company and pays interest and principal on a $1,000 with a 5% coupon in Canadian dollars. If the exchange rate at the time of purchase is 1:1, then the 5% coupon payment is equal to $50 Canadian, and because of the exchange rate, it is also equal to $50 U.S.that make interest and
Now let's assume a year from now the exchange rate is 1:0.85. Now the 5% coupon payment, which is still $50 Canadian, is worth only $42.50 U.S. The investor has lost a portion of his return for reasons that had nothing to do with the issuer's .
Why it Matters:
Currency risk matters because exchange rates affect the amount of rate of return ultimately is.the investor actually sees at the end of the day, and this in turn determines what the investor's
However, currency risk can create opportunities because the interest rates between two countries often reflect expected changes in thebetween them. For example, if interest rates are higher in Canada, the U.S. dollar probably decline in value relative to the Canadian dollar. (This is because when interest rates increase in a particular country, international flows into that country to capture the higher yields. This pushes the value of that country's higher.) Currency risk also means that investors in foreign can indirectly participate in the foreign-exchange markets.