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Definition: Foreign Currency Effect
When an investor makes an investment in a foreign country, thereturns on the investment fluctuates depending upon thecurrency value of the foreign country with respect to the home currency. This is called as Foreign Currency Effect.
For example, if suppose an investor from US buys the stock of a company here in India, he/she receives returns in the form of dividends. Suppose the investor receives a dividend of Rs. 1000as issued by the company. As per the current exchange rate(which is 1 US dollar = Rs. 54), the investor would receive only$19 in return. However if the exchange rate become Rs. 48 per dollar, the investor would receive $21 in returns. This variability in the return on investment due to the changes in the currency value is termed foreign currency effect.
Foreign Currency Effect is also a source of risk which is intrinsic in any foreign investments. If the investor’s home currency strengthens, the returns will be greater thus resulting in a gain and similarly vice-versa.