When I think about explaining currency risk, I use the example of going on holiday and taking a break somewhere in Europe; or more specifically the EU zone.
At the time of writing my British pound buys me one euro fifteen cents or expressed another way: £1: €1.15. Yet, before the Brexit referendum in July 2016, the rate was £1: €1.30.
In practice, what this means is that the €90 in toll fees that I was charged to drive from Calais to Carcassonne cost me £69 in July 2016 and would cost me £78 if I were to jump in my car immediately post-Brexit and head off. £9 more expensive.
So, currency risk is the risk that you will lose money or suffer a financial loss as a result of fluctuations in exchange rates between different currencies over a period of time.
Currency risk taken on by governments
The same risk principle applies whether it is my road trip through France or the Argentinian government borrowing money in US dollars from an American investment bank.
In the latter example, if the Argentinian government borrowed US$ 10 million from an American investment bank in October 2017, they would have received 174 million Argentinian pesos based on the Dollar: Peso exchange rate at that time.
If the Argentinian government was to repay that US$ 10 million today (January 2020) then they would need to find 596 million Argentinian pesos. That is a significant loss (on paper) and has been brought about by the strength of the US dollar in global currency markets today, combined with the weakness of the Argentinian peso owing to an under-performing, over-indebted economy.
So, you can see that currency risk (FX risk), can have significant economic consequences on individuals, companies and governments, and can result in real financial losses. However, these risks can be mitigated by a finance concept known as hedging or currency risk management.
Currency risk management
The risk of financial loss from foreign currency movement can be managed through the use of hedging strategies.
To illustrate this concept in practice, you can read a case study of Spanish fruit company exporting to a UK supermarket, by following the link.
