What is Exchange Rate Risk?

Exchange rate risk only applies in the case of bonds that are not denominated in the local currency of the holder. The holder has the risk that the currency in which the bonds are denominated depreciates, in which case the holder will receive less periodic interest and less of the principal amount on maturity in the local currency. ‘Ibis risk is also referred to as currency risk.

For example, assume ABC Company is a American company and pays interest and principal on a $2,000 bond with a 7% coupon in American dollars. If the exchange rate at the time of purchase is 01:01, then the 7% coupon payment is equal to $60 American, and because of the exchange rate, it is also equal to US $60.