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 is the Mont Pelerin Society?

    The Mont Pelerin Society was formed in 1947 when economist Friedrich von Hayek invited 39 people to meet at Mont Pelerin ...
  2. What's the best way to play backwardation in the futures market?

    Backwardation is a market condition in which a futures contract far from its delivery date is trading at a lower price than ...
  3. What's the difference between binary options and day trading?

    Binary options and day trading are both ways to make (or lose) money in the financial markets, but they are different animals. ...
  4. What is a BRIC nation?

    BRIC is an acronym for the combined economies of Brazil, Russia, India and China. The economies of these four nations are ...
RELATED TERMS
  1. Foreign remittance

  2. Multibank Holding Company

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

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

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

    An extended period of economic decline around the world. The ...
  6. Cash-And-Carry Trade

    A trading strategy in which an investor buys a long position ...
comments powered by Disqus
Related Articles
  1. The Economics Of Labor Mobility
    Economics

    The Economics Of Labor Mobility

  2. Examining The Phillips Curve
    Economics

    Examining The Phillips Curve

  3. The Causes And Effects Of Credit Shocks
    Insurance

    The Causes And Effects Of Credit Shocks

  4. Combating Retirement's Silent Killer: ...
    Retirement

    Combating Retirement's Silent Killer: ...

  5. What Is Fiscal Policy?
    Economics

    What Is Fiscal Policy?

Trading Center