Currency Risk
The risk that changes in exchange rates will reduce the value of foreign investments when converted back to the investor's home currency.
What is Currency Risk?
Currency risk (also called foreign exchange risk or FX risk) is the potential for losses resulting from adverse changes in exchange rates. When an investor holds foreign assets — foreign stocks, bonds, or real estate — the return in their home currency depends on both the asset's local performance and the movement of the exchange rate. If the foreign currency depreciates against the home currency, returns are reduced when converted back. Conversely, currency appreciation amplifies returns. Currency risk can be hedged using forward contracts, futures, options, or currency-hedged ETFs — but hedging has costs. For long-term equity investors, academic research suggests currency risk partially diversifies over time, making hedging less critical than for bond or short-term investors.
Example
A US investor bought a Japanese stock index fund in January 2022 that gained 10% in yen terms over the year. However, the yen fell 20% against the dollar in 2022. The US dollar return was approximately -12% (10% gain in yen × 0.80 yen/USD ratio) — a loss despite the local market rising. Currency risk turned a local gain into a dollar-denominated loss.