Exchange rate changes decreases risk of foreign investment

Question

Would exchange rate changes always raise the risk of the foreign investment? Explain some of the condition under which exchange rate changes can actually decrease the risk of foreign investment.

Answer 1

Changes of exchange rate need not always increases the risk of foreign investment. When covariance between exchange rate changes and local market returns is sufficiently negative to offset the positive variance of exchange rate changes, exchange rate volatility may actually decrease the risk of foreign investment.