What risks do organizations face when engaging in international finance activities?

By Nicola Sargeant AAA
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. What are some examples of times when I would need a letter of credit?

    Learn more about the function of a letter of credit for both the buyer and the seller, and get some examples showing when ...
  2. What are the different types of letters of credit?

    Learn more about the different types of letters of credit that are used to facilitate exchanges between parties that might ...
  3. What are the main reasons for why there could be a negative gross profit margin and ...

    Find out how to calculate a company's gross profit margin, why a firm might experience a negative margin and how to interpret ...
  4. Where is cost of living lowest in the world?

    Learn how the cost of living is the lowest in India based on numbers derived from the CPI and organizations like Expatistan ...
RELATED TERMS
  1. Welfare Capitalism

    Definition of welfare capitalism.
  2. Foreign remittance

  3. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  4. Short Put

    A type of strategy regarding a put option, which is a contract ...
  5. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  6. Global Recession

    An extended period of economic decline around the world. The ...
Related Articles
  1. Stock Safety: Top 3 Ways to Limit Your ...
    Options & Futures

    Stock Safety: Top 3 Ways to Limit Your ...

  2. Ever Wanted to Own International Stocks? ...
    Economics

    Ever Wanted to Own International Stocks? ...

  3. Applying Binary Options To Equity Markets
    Options & Futures

    Applying Binary Options To Equity Markets

  4. Can You Buy Stock Insurace? 3 Strategies ...
    Options & Futures

    Can You Buy Stock Insurace? 3 Strategies ...

  5. Hong Kong And China's Touchy Ties
    Investing

    Hong Kong And China's Touchy Ties

Trading Center