Foreign Exchange Issues
Globalization and technology have opened up the world and the world of investment to the general public. An investor based in the United States is no longer limited to investing only in U.S. stocks and bonds, but can now buy shares of a Norwegian solar company while trading the Japanese yen. There are issues, however, when investors are subject to foreign exchange rates.
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Value
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Foreign exchange is globalization, and includes the exchange of goods and services and currencies. It has enriched our world with the variety of choice we have at the supermarket or at the wine shop, and with the companies and currencies we are free to invest in online. This freedom to invest almost wherever we please helps to create value in different areas of the world in the time it takes to click a mouse. But value can be relative.
When Gains Are Losses
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Perhaps an investor has bought $10,000 worth of shares of a company on a foreign exchange in a currency that is not the U.S. dollar. For example, say the investor bought $10,000 worth of shares of Commerzbank, a German bank that trades on a German exchange. The shares purchased were in euros. This means that the shares of Commerzbank could rise and the investor might still see a loss because the U.S. dollar rose against the euro.
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Weighing Risk
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In the hypothetical Commerzbank example, the investor was correct about the direction of the share price of Commerzbank, but still lost money on his investment because the exchange rate went against him. That is always one of the risks an investor takes when he gets involved in foreign exchange rates, either through investing in foreign companies or speculating on foreign currencies themselves. Investments that are subject to foreign exchange are more challenging because there is the added currency risk that must be weighed.
Confidence Is King
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Investment in foreign lands and therefore in foreign currencies adds a level of complexity to weighing the risk because the investor has to have a general idea about where the foreign currency is headed. Though there are innumerable methods for trading currencies and figuring out the direction a currency is headed in in relation to the U.S. dollar, no method is foolproof. What is certain is that behind the value of currencies is confidence. Confidence is what backs paper money, and this should be kept in mind when investing in foreign companies and currencies.
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References
- Casualty Actuarial Society: Foreign Exchange Rate Risk: Institutional Issues and Stochastic Modeling; Richard W. Gorvett
- International Trade Administration: Trade Finance Guide: Chapter 12: Foreign Exchange Risk Management; April 2008
- ABC-Amega Inc.: Increase in USD Value Abroad Poses Difficult Foreign Exchange Issue for US Exporter; Oct. 2008
- Foreign Exchange Services: US dollar foreign exchange rate weakens against major currencies; April 6, 2011
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