Risk Factors

Currency Risk

1

Currency risk arises when the value of a currency changes in relation to another currency. It can impact investors or companies that do business in other countries.

2

Currency risk can reduce the returns that investors make on foreign stock markets. This is because their return would partly depend upon the relationship of their home currency and the foreign currency.

3

Even domestic companies can be affected by currency risk. This is because most businesses rely on buying supplies in other countries and the price of those goods depends on the currency exchange.

4

When it comes to minimizing currency risk, the best companies to invest in are the companies that have a strong global presence. This is because they do business in most currencies and can hedge the risk.

  • Currency risk is slightly more complex as companies can operating in different countries to vary degrees.

  • For example, Company A may operate 25% of their business in Turkey, exposing themselves to weakness to the Turkish Lira by 25% of their total income.

  • The impact upon Company A’s income depends upon what other countries it operates in and how correlated the currency of said company is with the Turkish Lira.

  • For simplicity, the more countries that a company operates in, the more reduced the currency risk is.

  • The most obvious distinction when it comes to currency risk is between domestic and international companies. Domestic companies (operating in a single country) are very vulnerable to currency movements, while international companies are more protected.

  • This concept is best illustrated by Brexit, whereby international companies thrived and domestic companies dwindled.

  • The reason for this is that domestic companies often rely on importing goods from other countries, where they don’t have a presence. When the pound devalued as a result of the Brexit vote, importing goods became more expensive for British firms that only operate domestically.

  • International firms, like BP, thrived on the other hand as they were able to convert their foreign currency into more pounds.

  • For this reason, it’s important to diversify currency exposure in a portfolio in order to avoid currency vulnerabilities.

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