So you’ve discovered foreign currency investing. Your interest is piqued, and you’re curious to learn more about this potentially lucrative investing alternative. When investing, it’s essential to always know your down-side-risk. This notion applies to every investment opportunity, including real estate, the stock market, and currency investing. Foreign exchange risk (also referred to as exchange rate risk) is the possibility of currency risk due to exchange rate instabilities.
This possibility should be understood before you begin investing in currency. But you may wonder what the risks are. Keep reading to learn about the risks of investing in foreign currency.
3 Kinds of Foreign Exchange Risks
1. Economic Risk
Also referred to as forecast risk, economic risk is when a company’s market value is affected by inevitable vulnerability to exchange rate oscillations. Such risk is typically formed by macroeconomic circumstances such as intergovernmental fluctuations and instability.
2. Transaction Risk
Transaction risks are faced by many companies when propelling monetary transactions between jurisdictions. The risk is the exchange rate change before the settlement of the transaction. Moreover, the transaction and settlement time delay is the transaction risk source.
Transaction risks can be reduced by utilizing forward contracts.
For instance, let’s say a Canadian organization operating in Japan attempted to transfer 600 JPY (Japanese Yen) in revenue to its Canadian account. If, at the time of the transaction, the exchange rate was 1 CAD for 100 JPY, and the rate thereupon drops to 1 CAD for 7 JPY before settlement, a predicted receipt of CAD100 (JPY600/6) would instead be CAD86 (JPY600/7).
3. Translation Risk
Translation risk refers to the risk encountered by companies situated domestically but doing business in foreign jurisdictions. The company’s monetary performance is rationed in its domestic banknotes. Additionally, translation risk is increased when a company uses foreign currency to carry more significant amounts of its assets, liabilities, and equities.
For instance, a conglomerate reporting in Canadian dollars but managing a subsidiary established in China will encounter translation risks. The reason is that the subsidiary’s monetary performance – Chinese yuan – is decoded into the Canadian dollar for documentation objectives.
Understanding Foreign Currency Risks
As with anything in life, foreign currency investing involves risk. But by understanding these risks, you can position yourself to avoid them and, as a result, benefit from the many advantages that currency investing has to offer. At CWS Capital, we are a team of experienced fund managers and data analysts who have been helping Canadians strengthen their portfolios for nearly a decade.
If you’re interested in learning more about how we can help, contact us today to see if you qualify for forex investing assistance.