What Are Foreign Currency Effects?

Foreign currency effects is a business term used to describe the way changes in the value of the domestic currency for a place of investment, in relation to the value of the currency in the country of the investor, affects the investments owned by the investor in the foreign country. The main determinant of foreign currency effects is derived from any type of discrepancy in the exchange rates of the two currencies as a result of the external or internal microeconomic or macroeconomic factors. As such, foreign currency effects may be in the form of loses if the discrepancy is negative in relation to the investor’s currency. They may be in the form of profits if the differences in the value of the currencies reflect positively on the currency of the investor.

An illustration of foreign currency effects can be seen in a situation where a company from the United States has a subsidiary in Japan. Assuming the two currencies hold steady, the company from the United States usually makes a stated percentage in profits after the conversion of the money realized from its dealings in Japan. On the other hand, if the value of the Japanese money rises, this will likely result in a loss for the United States company since it means that the value of the US currency has dropped in relation to the Japanese currency. The opposite effect will be true if the value of the Japanese currency drops, because the value of the US currency will gain some strength in relation to the local money, leading to an increase in the profits of the company.

Another application of foreign currency effects can be seen in the case of physical investments in the foreign country, or in the case of other types of investment that may include securities and other related investments. Assuming a company has physical assets in a foreign country that include land and other types of real estate and properties, the value of such items will be affected by fluctuations in the two currencies related to the investor. In the first place, changes in the local currency will affect the value of the property as well as changes in the value of the foreign currency. Where this is the case, the investor will stand to either gain or lose when there are changes in the currency, depending on what direction the changes take.