# Currency risk

Currency risk is the possibility that exchange-rate changes alter the value of an investment or its cash flows when measured in the investor’s home currency.

## What it means

A stock can gain value in its trading currency while losing value when translated into your home currency. The difference comes from movements in the exchange rate. For a US-dollar investor holding a euro-denominated stock, both the stock’s euro price and the euro’s US-dollar value affect the investment’s dollar value.

Currency risk also applies to dividends paid in another currency and to proceeds converted after a sale. A stock’s trading currency is not necessarily the same as the currencies in which its business earns revenue or pays costs. Those business exposures can affect the stock price, but they are distinct from the direct translation of a foreign-currency holding.

## How it is calculated

For a holding bought and valued in one foreign currency, ignoring dividends, taxes and trading costs:

`Home-currency return = (1 + local-currency return) × (1 + currency return) − 1`

- **Home-currency return:** Percentage change in the holding’s value measured in the investor’s home currency.
- **Local-currency return:** Percentage change in the stock price measured in its trading currency.
- **Currency return:** Percentage change in the home-currency value of one unit of that trading currency. For a US-dollar investor holding a euro stock, it is the change in US$ per €1.

The currency return is `ending exchange rate / starting exchange rate − 1`, provided both rates use the same quotation convention. The multiplication matters: simply adding the two percentage changes leaves out their interaction. The formula describes the exchange-rate effect; it does not assign a probability to future currency moves.

## Worked example

These are hypothetical round numbers, with no dividends or trading costs:

1. A US-dollar investor holds a stock worth **€1,000**. At **US$1.20 per €1**, its starting value is **US$1,200**.
2. The stock rises **10%** in euros, making it worth **€1,100**.
3. The exchange rate moves to **US$1.00 per €1**. The ending dollar value is **€1,100 × US$1.00/€1 = US$1,100**.
4. The local-currency return is **10%**. The currency return is **1.00 / 1.20 − 1 = −16.67%**. The home-currency return is **1.10 × (1.00 / 1.20) − 1 = −8.33%**.

Despite the euro price gain, the holding’s dollar value falls by **US$100**, or about **8.33%**. The result would differ if the euro strengthened instead.

## Why it matters before you trade

A pre-trade check can identify which currency each holding uses, which currency you use to assess results, and whether you expect to convert cash for the purchase or sale. It can also distinguish an exchange-rate change from a broker’s currency-conversion charge: both affect the dollars received, but only the former is currency-market risk.

For a basket spanning several markets, consider its currency breakdown rather than assuming that different stock tickers mean different currency exposures. Holdings in the same trading currency can move together in home-currency terms when that currency changes. Currency exposure is one part of the basket’s risk, not a substitute for assessing stock-price volatility, liquidity or concentration.

## How PreTrAIde uses it

PreTrAIde is an AI platform for **pre-trade analysis** of stock baskets. Its quantitative layer provides a portfolio breakdown by currency, alongside breakdowns by country, sector, region and market capitalization. This can help a user see which currencies appear in a proposed basket before placing an order with their own broker.

PreTrAIde also returns basket-level and line-level verdicts with risk assessments and plain-language reasoning. Its stated product features do not include a dedicated foreign-exchange forecast, a currency-hedging service or a standalone currency-risk score. Its verdicts are decision support, not investment recommendations.

## Common mistakes

- **Reading a local-currency gain as a home-currency gain.** Conversion can reverse the result, as in the example.
- **Using the exchange rate backward.** If the quote is US$ per €1, multiply euros by that rate to obtain dollars.
- **Adding percentage returns without checking.** The exact combined return includes the product of the stock and currency changes.
- **Treating trading currency as total economic exposure.** A company’s revenues and costs may involve other currencies.
- **Confusing currency risk with conversion fees.** A fee is a transaction cost; an exchange rate can move while the holding is owned.

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Source: https://pretraide.com/glossary/currency-risk