Explain the concept of currency risk. How can inflation and interest rates create currency risk?

What will be an ideal response?

Exchange rate fluctuations and similar complications in international business create currency risk, the potential harm that can arise from changes in the price of one currency relative to another. If you buy from a supplier whose currency is appreciating against yours, you may need to pay a larger amount of your currency to complete the purchase. If you expect payment from a customer whose currency is depreciating against your own, currency risk also arises, because you may receive a smaller amount of your currency if the sale price was expressed in the currency of the customer. Of course, if the foreign currency fluctuates in your favor, you may gain a windfall. Exporters or importers usually are not in the business of making money from currency speculation; rather, they worry about losses that arise from currency fluctuations.
Inflation and interest rates can create currency risk. Inflation is an increase in the price of goods and services, so that money buys less than in preceding years. Interest rates and inflation are closely related. In countries with high inflation, interest rates tend to be high because investors expect to be compensated for the inflation-induced decline in the value of their money. If inflation is running at 10 percent, for example, banks must pay more than 10 percent interest to attract customers to open savings accounts.
Inflation occurs when 1. demand for money grows more rapidly than supply, or 2. the central bank increases the nation's money supply faster than the national productive output. For instance, triggered by big increases in the national money supply, inflation ran to more than 400 percent per year in Brazil in the mid-1990s. Inflation is a common challenge for developing economies and emerging markets.
Inflation directly affects the value of the nation's currency. If it results from an excessive increase in the money supply, all else being equal, the price of that money (expressed in terms of foreign currencies) will fall.
The link between interest rates and inflation, and between inflation and the value of currency, implies there is a relationship between real interest rates and the value of currency.