Foreign Exchange Risk
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Foreign exchange risk is a risk posed by the dynamic nature of exchange rates during international trade, which can negatively impact the return on an investment or transaction. Many geopolitical and economic factors impact exchange rates, creating risk that one or both currencies will change in value during the course of dealing between parties.
The longer that parties engage in trade or business using different currencies, the higher the foreign exchange risk. Consider the following scenario: an American manufacturer enters into a Yuan-denominated contract with a Chinese producer. At the time the contract was formed the exchange rate between dollars and yuan was 1:1. However, over the course of dealing, macroeconomic pressures depreciated the Yuan in relation to the dollar. As a result, the Chinese producer, who is still being paid the same nominal amount of Yuan, loses profit.