The risk that is inherent in cross-currency investments/ positions where the correlation between investment/ position returns and exchange rates impact the performance and outcomes of the entire investment/ position. It is a currency risk that arises in connection with cross-border investing where the returns on foreign assets are measured in the base currency (currency of its domicile). A correlation coefficient is established an a key input in valuation of such investments/ positions. It measures the relationship between the returns of such foreign assets (denominated in the local currency or home currency) and the exchange rate between the investor’s local currency and the asset’s foreign currency.
The returns could be positively or negatively correlated, or uncorrelated, with the exchange rate.
This type of risk is also known as an omega risk.
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