Investors are increasingly turning to global markets to find opportunities for profit, giving urgency to the issue of protecting returns from foreign exchange risk. While are many excellent investment opportunities to be found all over the world, volatility in the currency markets can and does affect the profitability of these investments. An understanding of how currency rate movements can affect profits can help investors protect their bottom line from this uncertainty.
Exchange Rate Volatility Risk for Equity Investors
An vivid example of how currency volatility can impact profits occurred in 2004. When the US stock market rallied, investors from Europe converted their euros into dollars and sent them to America to take advantage of these opportunities.
Even though there was a 30% gain in the US stock market that year, it was accompanied by a 22% decline in the value of the dollar. Although the European investors had earned substantial returns on their stock investments, their profits were reduced considerably when converted back into euros because of the decline in the dollar!
Exchange Rate Risk for Bond Investors
Investors in other markets are also exposed to currency rate risk. When interest rates increased in the UK, many investors sent capital from all over the world to profit from these higher returns.
However, at the same time, the price of the US dollar versus the pound sterling was subject to great volatility -as much as 11% in 2004! Because of this, the amount that American investors took home varied greatly depending on when they chose to convert their profits back into dollars.
Protect Your Investment from Uncertainty
Exchange rate risk can be a threat to your profitability when investing abroad. While it is impossible to predict exactly where the markets will go, you can protect yourself from this kind of volatility! Read on to learn how easy it is to hedge against currency exchange risk by taking a position in the spot foreign exchange market!
For more information please read: Hedging Against FX Risk