Foreign exchange risk is the possibility that the value of a transaction or an investment will change because of variations in currency exchange rates. For example, a seller commits to be paid in 60 days in a different currency; if the value of that currency declines during the intervening time period, the seller will incur a loss when the receivable is paid.
This is a significant risk for businesses engaged in exporting or importing activities where some of their transactions are conducted in a different currency than the entity’s home currency. This risk is also a concern when investments are made in a foreign currency, since a loss may be incurred on the investment when it is eventually sold and the funds are converted back into the investor’s home currency.
Foreign exchange risk can be mitigated by entering into offsetting hedging transactions, as well as by insisting that all transactions by conducted in one’s home currency.