Foreign exchange risk is a critical aspect of financial planning and management for organizations and individuals involved in international transactions. This risk arises when the value of one currency changes relative to another, potentially affecting the financial outcomes of transactions, assets, or liabilities denominated in foreign currencies. For instance, if a U.S. company owes €1 million to a European supplier, and the euro strengthens against the dollar, the company will need more dollars to settle the debt. Conversely, if the euro weakens, the cost in dollars would decrease.

There are various types of foreign exchange risks, including transaction risk, translation risk, and economic risk. Businesses often use financial instruments like forward contracts, options, or swaps to hedge against these risks. For example, a company importing goods from a foreign supplier might lock in the exchange rate for a future payment using a forward contract. Properly managing foreign exchange risk can protect the business from adverse financial impacts due to unforeseen currency fluctuations.