Currency risk — how exchange rates affect foreign investments. Currency risk (exchange-rate risk) refers to the possibility that changes in currency exchange rates will alter the value of foreign-denominated investments when converted back to your home currency. For example, a European stock that appreciates 5% in euro terms can still deliver a negative return in USD if the euro weakens sufficiently against the dollar. Currency moves can offset or amplify underlying asset returns and can be driven by interest-rate differentials, macroeconomic shifts, or political events. Currency exposure is effectively an additional source of volatility and return that investors must consider when adding international holdings.

Managing currency exposure and practical choices. Investors can manage currency risk via natural hedges (matching foreign liabilities to assets), using currency-hedged funds, or leaving exposure unhedged when expecting long-term currency mean reversion. Currency-hedged ETFs reduce exchange-rate volatility but incur costs (hedging fees and potential tracking differences). For long-term strategic allocations, many investors accept unhedged exposure because currency effects tend to wash out over very long horizons and hedging costs reduce long-term returns. For short-term investors or those sensitive to currency swings, hedging can be sensible. Evaluate the tradeoffs—costs, counterparty risk, and correlation to portfolio goals—before choosing a hedging approach.