Currency & Political Risk

The exam loves a directional puzzle: “U.S. investor owns Japanese stock; the dollar strengthens — what happens?” Read it backward from the dollar, not the stock. Watch for the hedging tell: the fix for currency risk is forward contracts, currency options, or currency-hedged funds, never “buy more foreign positions.” Political risk shows up as expropriation, nationalization, capital controls, sanctions, or abrupt tax/regulatory changes.

Mind the split: most prep banks treat currency risk as systematic — it’s the “E” (exchange-rate) in the PRIME list of non-diversifiable risks (purchasing-power, reinvestment, interest-rate, market, exchange-rate), so you hedge it, not diversify it away. Political risk, by contrast, is usually taught as nonsystematic — reduced by spreading across countries (a few banks instead bucket country-wide risk as systematic, so read the answer choices). Like market risk, the textbook systematic risk, currency exposure resists diversification. Don’t assume an ADR sidesteps it; it converts the mechanics, not the exchange-rate exposure. Hook: strong dollar, weak foreign returns.