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Emerging Markets – Currency Risk

Trading Term

Currency risk (FX risk) is the potential for investment returns to be altered by exchange‑rate movements between an asset’s local currency and the investor’s base currency. In emerging markets, FX regimes and external balances heavily influence this risk.

Transmission to returns: FX can dominate total returns: a strong local market may translate into negative USD returns if the currency depreciates, and vice versa. For debt, currency mismatches—borrowing in hard currency while earning local currency revenues—create balance‑sheet vulnerabilities that can trigger crises.

Risk management: Approaches include natural hedges (matching currency revenues and costs), financial hedges (forwards, options), and portfolio construction (tilting toward hard‑currency exposures). Understanding regime credibility—pegs, floats, managed floats—helps anticipate policy reactions to shocks.

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