What risk is posed by variations in exchange rates between countries?

Currency risk refers to the potential for financial loss due to fluctuations in exchange rates between two or more currencies. This risk is especially pertinent for businesses engaged in international trade or investment, where changes in currency values can impact the cost of imports, exports, or investments in foreign assets. If a company's home currency strengthens, for instance, it may find that its exports become more expensive for foreign buyers, potentially reducing sales. Conversely, if a currency weakens, the cost of imported goods may rise, affecting profit margins.

Understanding currency risk is crucial for businesses operating internationally, as it can influence pricing strategies, competitiveness, and even financial reporting. Companies often employ various financial instruments, such as forward contracts or options, to hedge against this risk, maintaining their financial stability.

In contrast, credit risk involves the possibility that a borrower will default on a loan, inflation risk pertains to the decrease in purchasing power due to rising prices, and liquidity risk involves the difficulty of selling an asset without incurring a loss. While these risks are important in their contexts, they do not directly relate to the impact of exchange rate fluctuations in international financial scenarios.