Currency risk arises whenever the currency of an asset does not match the currency of future expenses. An investor with income and expenses in local currency who invests in a dollar instrument earns or loses not only on the instrument itself, but also on currency movements.
The risk is two-sided, and this is often overlooked. A foreign currency deposit protects against weakening of the national currency, but when it strengthens, it performs worse than a local currency deposit with a higher rate. Similarly, high local currency returns contain compensation for currency risk, not a free premium.
The basic approach to management is matching the currency of savings with the currency of future expenses. If major expenses are planned in local currency, holding the entire portfolio in foreign currency is inefficient; if overseas education or medical treatment is planned, the opposite applies. Companies manage this risk through hedging, while individual investors typically have only currency diversification available.