Currency risk arises from fluctuations in the exchange rate between two currencies. For an investor, it emerges whenever there is exposure to assets denominated in a currency other than the metical. In such cases, the outcome of an investment may depend not only on the performance of the underlying asset but also on how the foreign currency moves against the national currency.
For example, an investor who puts money into a dollar-denominated asset is exposed not just to that asset's appreciation or depreciation, but also to the evolution of the exchange rate between the dollar and the metical.
If the asset gains in value but the dollar weakens against the metical, part of the gain may be wiped out by the currency effect. Conversely, if the dollar strengthens, that movement can boost the return on the investment when expressed in meticais.
Why Do Currencies Change in Value?
According to the financial portal Doutor Finanças, exchange rates are influenced by a range of economic and financial factors, including central bank decisions on interest rates, inflation, economic growth, trade and investment flows, and investor risk perception.
In Mozambique, fluctuations of the metical against other currencies can affect companies and investors exposed to international trade, imports and exports, external financing, or assets denominated in foreign currency.
Conditions in the international economy, commodity prices, and capital flows can equally influence the direction of exchange rates.
How Does Currency Risk Affect Investors?
An investor holding assets denominated in a foreign currency is, in principle, exposed to that currency's fluctuations, unless hedging mechanisms are in place to manage currency risk.
Investing in US equities, for instance, may involve exposure to the dollar. The same applies to assets denominated in rands, euros, or other currencies. This effect can also materialise in funds, bonds, and other financial instruments that carry currency exposure.
It is not necessary to carry out a foreign exchange transaction directly in order to be subject to this risk. The impact becomes visible when the value of the investment is calculated in meticais.
Practical Example: Investing in US Equities
Consider a Mozambican investor who allocates the equivalent of one million meticais into a portfolio of US equities denominated in dollars.
After one year, the equities have risen by 10%. That gain does not, however, guarantee that the return measured in meticais is also 10%.
If, over the same period, the dollar loses value against the metical, part of — or, in certain circumstances, all of — the equity appreciation may be cancelled out by the currency effect.
If the opposite occurs and the dollar strengthens, the investor may benefit simultaneously from the rise in equity value and a favourable currency movement.
For this reason, the return on any international investment must also be assessed in the currency in which the investor measures their wealth — in this case, the metical.
Source: Diário Económico
Original article: https://www.diarioeconomico.co.mz/?p=550049
