Recent corporate earnings reports addressed world currency valuations and their impact on profits. It’s a good time to look at what currency risks we are dealing with as investors in a global economy.
3 Kinds of Risk
“If you hold stock in a company with overseas operations, currency fluctuations can impact profits. There are three kinds of currency risk for companies with foreign operations you should be aware of:
Translation risk – is the exchange rate risk associated with companies dealing in foreign currencies and then converting them back to the company’s home currency. This is particularly noticeable when currencies make significant moves, as seen with the U.S. dollar during the crisis and recovery.
Transaction risk – is the exchange rate risk associated with the time delay between when a company enters into a contract (for payment) and when it settles the contract (receives payment).
Economic risk – is the risk changes in currency have on economic growth and inflation in a country. Operating in a high-inflation environment can be difficult for businesses if they are unable to pass on price increases fast enough.
There are five main factors driving exchange rates: trade balances, fiscal policy, monetary policy, rate of economic growth and inflation.
It is the comparison of these five factors between countries that largely determines currency movements.”
Thanks to the Institute of Business and Finance for contributing.
Let me know if you have any questions or need any additional resources.