A:

When an organization decides to engage in international financing activities, they also take on additional risk as well as opportunities. The main risks that are associated with businesses engaging in international finance include foreign exchange risk and political risk. These risks may sometimes make it difficult to maintain constant and reliable revenue.

Foreign exchange risk occurs when the value of investment fluctuates due to changes in a currency's exchange rate. When a domestic currency appreciates against a foreign currency, profit or returns earned in the foreign country will decrease after being exchanged back to the domestic currency. Due to the somewhat volatile nature of the exchange rate, it can be quite difficult to protect against this kind of risk, which can harm sales and revenues.

For example, assume a <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" /?>U.S. car company receives a majority of its business in Japan. If the Japanese yen depreciates against the U.S. dollar, any yen-denominated profits the company receives from its Japanese operations will yield fewer U.S. dollars compared to before the yen\'s depreciation.

Political risk transpires when a country's government unexpectedly changes its policies, which now negatively affect the foreign company. These policy changes can include such things as trade barriers, which serve to limit or prevent international trade. Some governments will request additional funds or tariffs in exchange for the right to export items into their country. Tariffs and quotas are used to protect domestic producers from foreign competition. This also can have a huge effect on the profits of an organization because it either cuts revenues from the result of a tax on exports or restricts the amount of revenues that can be earned. Although the amount of trade barriers have diminished due to free-trade agreements and other similar measures, the everyday differences in the laws of foreign countries can influence the profits and overall success of a company doing business transactions abroad.

In general, organizations engaging in international finance activities can experience much greater uncertainty in their revenues. An unsteady and unpredictable stream of revenue can make it hard to operate a business effectively. Despite these negative exposures, international business can open up opportunities for reduced resource costs and larger lucrative markets. There are also ways in which a company can overcome some of these risk exposures.

For example, a business may attempt to hedge some of its foreign-exchange risk by buying futures, forwards or options on the currency market. They also may decide to acquire political risk insurance in order to protect their equity investments and loans from specific government actions. What a company must decide is whether the pros outweigh the cons when deciding to venture into the international market.

For further reading, see Forces Behind Exchange Rates, Corporate Use Of Derivatives For Hedging and Investing Beyond Your Borders.

RELATED FAQS
  1. How can I invest in a foreign exchange market?

    The foreign exchange market, also called the currency market or forex (FX), is the world's largest financial market, accounting ... Read Answer >>
  2. I live in the U.S. How can I trade stocks in China and India?

    Foreign markets have always been an object of envy to domestic investors because the indexes in some foreign countries have ... Read Answer >>
  3. How are international exchange rates set?

    International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency ... Read Answer >>
  4. How do businesses decide whether to do FDI via green field investments or acquisitions?

    When businesses decide to expand their operations to another country, one of the more important dilemmas they can face is ... Read Answer >>
  5. What are the different sources of business risk?

    Explore the various sources of business risk for companies and learn how critical risk management is to a company's financial ... Read Answer >>
  6. What is the difference between market risk and country risk?

    Learn about market risk and country risk, some examples of each and the main difference between these two types of risks. Read Answer >>
Related Articles
  1. Mutual Funds & ETFs

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  2. Economics

    Cautionary Signs For International Investors

    "Going global" is a fashionable investing style, but investors should know the risks.
  3. Investing Basics

    Broadening Your Portfolio's Borders

    Find out what type of international fund might suit your needs in gaining exposure to foreign markets.
  4. Mutual Funds & ETFs

    Getting Into International Investing

    Diversifying can mean not only investing in various asset classes but also venturing beyond domestic exchanges.
  5. Economics

    Ever Wanted to Own International Stocks? Here's How

    Tips and strategies for users to trade in different exchanges around the world.
  6. Mutual Funds & ETFs

    Playing It Safe In Foreign Stock Markets

    Find out some of the lower-risk ways to invest in foreign markets.
  7. Options & Futures

    Exploring Non-Dollar Currencies For Forex Trading

    Learn how investments in foreign currencies can diversify your portfolio.
  8. Economics

    Macroeconomics: Currency

    By Stephen Simpson For citizens of different countries to conduct trade, they have to buy and sell each other's currencies. The price of a nation's currency, expressed as an amount of a second ...
  9. Mutual Funds & ETFs

    Go International With Foreign Index Funds

    As global trade continues to expand and the world's economies grow, spice up your portfolio with these exciting opportunities.
  10. Options & Futures

    Evaluating Country Risk For International Investing

    Investing overseas begins with determining the risk of the country's investment climate.
RELATED TERMS
  1. Foreign Exchange Reserves

    Foreign exchange reserves are reserve assets held by a central ...
  2. Translation Risk

    The exchange rate risk associated with companies that deal in ...
  3. Foreign Debt

    An outstanding loan that one country owes to another country ...
  4. Currency Substitution

    The use of a foreign currency in transactions in place of the ...
  5. Transaction Exposure

    The risk, faced by companies involved in international trade, ...
  6. Foreign Investment

    Flows of capital from one nation to another in exchange for significant ...
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center