How currency risk affects your investments and Indian companies

If you invest in US shares, your returns depend not only on those shares but also on the rupee-dollar exchange rate. This is currency risk, also called FX risk. This page explains how it works for investors and companies, and how it can be managed.

Quick answer

Currency risk, or foreign exchange (FX) risk, is the chance that changes in exchange rates reduce the value of an investment or the profits of a business. For Indian investors holding foreign assets, a stronger rupee lowers returns in rupee terms. For companies, a weaker rupee raises the cost of imports and foreign loans, but helps exporters.

Key takeaways

• It comes from changes in exchange rates.
• A stronger rupee reduces returns on foreign investments in rupee terms.
• A weaker rupee hurts importers and helps exporters.
• Companies use forwards and futures to hedge it.
• Foreign investors in India also face rupee risk.

What is currency risk?

Whenever money crosses borders, it has to be converted from one currency to another. Exchange rates move every day. This risk is the chance that these moves work against you, reducing what you earn or increasing what you owe.

It affects individual investors with foreign assets, companies that trade abroad and foreign investors who put money into India.

Currency risk for Indian investors

Suppose you invest Rs 84,000 in a US fund when 1 US dollar equals Rs 84, so you hold USD 1,000. A year later, the fund is worth USD 1,100, a 10 percent gain in dollars. If the rupee has weakened to Rs 88, your holding is worth Rs 96,800, a gain of about 15 percent in rupees.

If instead the rupee strengthened to Rs 80, your holding would be worth Rs 88,000, a gain of only about 4.8 percent. The investment was the same, but the currency move changed your rupee return.

Currency risk for companies

Companies that import oil, electronics or raw materials pay more when the rupee weakens. Companies with loans in US dollars, such as external commercial borrowings, need more rupees to repay. On the other hand, exporters like IT services and pharma firms earn more rupees for every dollar of sales.

So the same rupee move can help one sector and hurt another. This is why analysts look at a company's foreign currency revenue and costs when studying its results.

How is it managed?

Companies often hedge using forward contracts with banks or currency futures and options on exchanges. These lock in an exchange rate for a future date, which reduces uncertainty but has a cost and removes the benefit of a favourable move.

Individual investors usually accept the currency exposure as part of international diversification. Some international funds hedge it, while most do not. Knowing whether your fund is hedged helps you understand its returns.

The key point to remember

Currency risk can add to or take away from returns in ways that have nothing to do with the underlying asset. Understanding it helps you judge foreign investments and companies with large foreign trade.

Frequently Asked Questions