International Finance Risk
International Risk Paper
Organizations encounter financial risks in business everyday, especially when looking at capital budgeting. An organization can use capital budgeting techniques like; cost of capital, Net Present Value, and Internal rate of Return to value the amount of risk the organization is willing to take. When an organization decides to venture into the international arena different risks need to be analyzed. Some of the main International investment concerns are Exchange Rate Risk, Political Risk, and Cultural Risk. We will look at how these concerns can effect international investing and what tools are out there to help mitigate the risk.
Exchange Rate Risk
Exchange Rate Risk reflects the danger an unexpected change in the exchange rate between the dollar and the currency in which a project’s cash flows are denominated will reduce the market value of that project’s cash flow. The dollar value of future cash inflows can be dramatically altered if the local currency depreciates against the dollar. (Gitman) A tool to manage this exchange rate risk is an option. An option gives the buyer the right, but not the obligation, to sell a specified amount of foreign currency to an option seller at a fixed dollar price, up to an agreed upon expiration date. Another tool to manage exchange rate risk is a forward. A forward is similar to an option, but the firm will be obligated to make the transaction at a specific rate in a time period of one year.
Political Risk
Political risk happens when a country’s government unexpectedly changes its policies, which now negatively affect the foreign company. These policy changes can include trade barriers which serve to limit or prevent trade. Some governments will have tariffs in exchange for the right to export item into their country. (Investopedia) A foreign government could come and nationalize and seize control of a company’s assets. Obviously the seizure of a company is extreme but not unheard of.
Organizations encounter financial risks in business everyday, especially when looking at capital budgeting. An organization can use capital budgeting techniques like; cost of capital, Net Present Value, and Internal rate of Return to value the amount of risk the organization is willing to take. When an organization decides to venture into the international arena different risks need to be analyzed. Some of the main International investment concerns are Exchange Rate Risk, Political Risk, and Cultural Risk. We will look at how these concerns can effect international investing and what tools are out there to help mitigate the risk.
Exchange Rate Risk
Exchange Rate Risk reflects the danger an unexpected change in the exchange rate between the dollar and the currency in which a project’s cash flows are denominated will reduce the market value of that project’s cash flow. The dollar value of future cash inflows can be dramatically altered if the local currency depreciates against the dollar. (Gitman) A tool to manage this exchange rate risk is an option. An option gives the buyer the right, but not the obligation, to sell a specified amount of foreign currency to an option seller at a fixed dollar price, up to an agreed upon expiration date. Another tool to manage exchange rate risk is a forward. A forward is similar to an option, but the firm will be obligated to make the transaction at a specific rate in a time period of one year.
Political Risk
Political risk happens when a country’s government unexpectedly changes its policies, which now negatively affect the foreign company. These policy changes can include trade barriers which serve to limit or prevent trade. Some governments will have tariffs in exchange for the right to export item into their country. (Investopedia) A foreign government could come and nationalize and seize control of a company’s assets. Obviously the seizure of a company is extreme but not unheard of.