Final answer:
Foreign exchange risk occurs when the value of a currency changes as it is traded. Such fluctuations can have significant impacts on international trade and investment, affecting costs, profits, and economic stability.
Step-by-step explanation:
Foreign exchange risk occurs when the value of a currency changes as it is traded. In the foreign exchange market, individuals and firms exchange one currency for another for various purposes, including trade, investment, and speculation. Currencies can appreciate or depreciate in value relative to one another based on various factors such as differences in interest rates, economic growth, trade balances, and speculations.
When a currency appreciates, it gains strength and can buy more of another currency; when it depreciates, it loses strength and can buy less. This fluctuation can significantly affect businesses and investors who operate internationally, as it directly impacts the cost of imports and exports, the value of international investments, and the repatriation of profits. Central banks may intervene in foreign exchange markets to prevent excessive volatility and maintain a stable business environment.