Exchange Rate Risk
What is exchange rate risk? What is currency risk?
Exchange rate risk, also called currency risk, is the probability that a firm’s operations or value will be altered by currency exchange rates. If firms conduct business overseas, for instance, good may be purchased from them with Euros (when Europeans buy the goods) yet eventually need to be converted to U.S. Dollars to become retained earnings.
In a simplistic model assuming no currency hedging, if a firm sells a widget for 100 Euros when the Euro trades at equal value to the U.S. Dollar (USD) and then the Euro appreciates so that 1 Euro is equivalent to $75 USD (before the firm can convert the currency), the firm has actually lost $25 USD due to currency fluctuation (initially the 100 Euros were equal to $100 USD, hence the $25 USD loss now that they are only equal to $75 USD).