What is foreign exchange risk?

Foreign exchange risk refers to the potential for loss that arises from fluctuations in exchange rates, which can significantly impact the value of foreign currency transactions. When a company or investor trades or holds assets in foreign currencies, any change in the exchange rates between the currencies can result in a gain or loss. For instance, if a U.S.-based company conducts business in euros and the euro weakens against the dollar before the transaction is converted back to dollars, the company would receive less value than initially expected, leading to a financial loss.

This makes understanding foreign exchange risk crucial for companies engaged in international trade, investors holding foreign assets, or when financial decisions involve multiple currencies. The other choices focus on aspects like transaction fees or interest rate changes, which, while relevant in finance, do not directly capture the essence of foreign exchange risk as it is primarily concerned with exchange rate fluctuations affecting the value of currencies.