If you have made any international transaction, or if you have travelled abroad, you would have no doubt done a quick calculation to see how much the Indian rupee is worth in the currency of the country you are travelling to or the currency in which you are making your purchase.
In other words, you would have paid attention to the exchange rate. The exchange rate is simply the value of one currency in another currency. And it keeps fluctuating on a daily basis.
So, for instance, the value of 1 USD may be equal to Rs. 75 today. And tomorrow, if the rupee strengthens, 1 USD may be equal to just Rs. 70. These fluctuations give rise to something known as currency risk.
What is currency risk?
Currency risk is the possibility of loss occurring on account of currency or exchange rate fluctuations. It is also known as foreign exchange risk or forex risk, and it is particularly important for traders who are engaged in online trading of currencies.
Currency risk: An example
If you are interested in forex online trading, you need to understand how currency risk works. Let us take an example to decode this better.
Buying currency
Say you want to buy 100 USD today, when the exchange rate is 75 INR for 1 USD. So, in total, you will spend Rs. 7,500 to make your purchase.
Selling currency
Two days later, you want to sell your holdings. Now, say the exchange rate has changed to 76 INR for 1 USD. This means you can sell your holdings for Rs. 7,600, thereby gaining Rs. 100.
On the other hand, if the exchange rate falls to 72 INR for 1 USD, you can only sell your holdings for Rs. 7,200. This will lead to a loss of Rs. 300.
So, this is how exchange rate fluctuations can lead to losses. And the possibility of facing a loss in forex trading online is what we call currency risk.
Important things you should know about currency risk
Before you get into online trading of foreign currencies, there are some important things to know about currency risk. Check them out below.
- Currency risk is not limited to forex trading only.
- You can experience currency risk with any foreign investments you make, such as international stocks or international equity funds.
- Currency risk cannot be eliminated.
- Currency risk can be managed with specific hedging strategies.
- Diversification is another strategy that can help reduce the currency risk in your portfolio.
- If your portfolio only contains investments valued in Indian rupee, its currency risk will be zero.
Conclusion
So, now that you know what currency risk is, you can draw up a plan to manage or mitigate this risk. Keep in mind that this risk is not specific to forex online trading alone. You can be exposed to currency risk even when you invest in international stocks through mutual funds.
If this is something you have been wanting to do, you can open a demat account with Motilal Oswal and start investing in global stocks via mutual funds today.
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