Future Business Leaders of America (FBLA) Securities and Investments Practice Test

How does currency exchange risk impact international investments?

1. It only affects long-term bonds

2. It can lead to increased dividend payments

3. It can diminish returns due to fluctuating currency values

4. It is irrelevant to U.S. dollar-denominated assets

The correct answer is: It can diminish returns due to fluctuating currency values

Currency exchange risk significantly impacts international investments because it involves the potential for loss due to changes in the exchange rate between two currencies. When investors put their money into foreign assets, the returns they receive can be influenced not just by the performance of the investment itself, but also by fluctuations in currency values relative to their home currency. For instance, if an investor purchases stocks in a foreign market, the value of those stocks may increase in local terms. However, if the foreign currency depreciates against the investor's home currency during the holding period, the returns when converted back to the home currency could be reduced, or even result in a loss. This risk is particularly pertinent to investors who do not hedge their currency exposure. While long-term bonds may be impacted by currency risk, it is not limited to them. Additionally, an increase in dividend payments does not directly correlate with currency risk—instead, it may be affected by the company’s profitability and internal policies. Finally, currency exchange risk is very relevant to U.S. dollar-denominated assets, particularly in global markets where fluctuations in currency can still affect the value of those assets when evaluated in a foreign currency context. Therefore, understanding and managing currency exchange risk is crucial for investors engaged in international markets.