Exchange Rate Fluctuations and Fixed Income Securities

 The value of a currency is influenced by the demand for it in foreign markets. If there is a great demand for a particular currency, its value will increase. Conversely, if there is a lack of demand for a particular currency, its value will decrease. The value of a currency about the US dollar is referred to as the exchange rate.

In the world of fixed income securities, currency risk is one of the most common types of risk. This refers to the possibility that the value of fixed income security will decrease due to a change in the exchange rate between the currency in which the security is issued and the currency in which the security is bought and sold. This is also known as a currency adjustment. The two primary ways in which fixed income security is exposed to currency risk are through interest rate fluctuations and changes in the exchange rate.

Currency risk or exchange rate in fixed income securities is the possibility that the value of fixed income security will decline in foreign currency if the currency of the country where the security is issued or the currency in which the security is issued is devalued. The opposite is called the exchange rate in fixed-income securities, which is the possibility that the value of fixed-income security will increase in the currency of the country where the security is issued or the currency in which the security is issued. Both risks affect the value of a security and are measured by the change in the value of the security. The direction of currency risk is affected by the interest rate in the country where the security is issued or the currency in which the security is issued.

The exchange rate between two currencies is the most common measurement of currency risk, but currency risk also exists in fixed-income securities. For example, a bond with a fixed coupon, or interest rate, in USD but with a floating interest rate in EUR may experience a currency risk premium if the exchange rate moves towards the EUR. This is because a bond with a EUR coupon is worth less in USD than it was when the bond was issued, and as a result, the bond's yield is higher in USD than it was when the bond was issued.

The exchange rate, also called the currency risk, of fixed income securities is the price of those securities in other currencies. When the exchange rate is favorable, the security is worth more in the original currency. When the exchange rate is unfavorable, the security is worth less in the original currency. The exchange rate is not the same as the interest rate, which is the amount paid or received on the security.