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Definition: Foreign Exchange Risk
Exchange rate risk is the risk associated with the fluctuating exchange rate or the changing value of one currency with respect to another. With an exchange rate risk, an investor or importer/exporter may end up losing or even making money.
For examples if the exchange for USD moves from Rs40 per dollar to Rs.55 per dollar, importers in India are at risk since they have to make payments in USD. At the same time, the exporters will benefit as they will receive payment in USD and hence get more amount in Rupees on conversion.
Exchange rate risk affects investors with operations, loans, investments in foreign currencies.
Another example can be illustrated as follows:
An Indian company with operations in U.S has taken a loan in US for 10,000 USD. At the time of taking the loan the conversion rate for 1 USD was Rs. 45. However, a few months later, the exchange rate moves to Rs.55 per dollar. Hence the company need more Rupees to pay every dollar of the interest and the principle. However, had the exchange rate moved to Rs. 40 per dollar, the company would have benefitted by paying less Rupees per dollar.