International Risk Term Paper

International Risk Management

No profit was ever made without taking some financial risk. However, economists such as John Eatwell and Lance Taylor have argued in their text Global Finance at Risk: The Case for International Regulation that international financial markets are intrinsically and particularly apt to pose the threat of risk to potential investors on an individual and a corporate level. Investors in finance base their decisions on guesses, not only about how other investors within a nation will behave, but also about national stability, which affects the stability of the currency. As markets have grown more global in scope, industrialized countries often have pursued a more cautious monetary policy regarding other nations. However, too much caution can be risky too, Ultimately hesitancy in investment results not only in lost opportunities, but a climate of fear that can at its extremes generates international deflation, a depression in economic growth, and unnecessary limiting of international growth and development. (Eatwell & Taylor, 2000)

Still, most international and national businesses prefer minimizing their potential exposure, to foreign exchange risks. Risk must be embarked upon, but judiciously. Unfortunately, as of late, the U.S. economy has become particularly vulnerable to charges of risk because of its current account deficit with other nations, the unwillingness of foreigners to buy U.S. securities based on the increasing national debt, which shows no sighs of abating, and also the perception that U.S. consumers as a whole lack confidence in their economy's growth potential. (Eatwell & Taylor, 2000) The U.S. dollar has been steadily weakening as a result. The United States' continued investment in Iraq and the ever-strengthening Euro does not bode well for the dollar as a currency, although investors with no political or personal interest in the U.S.'s financial health can at least take comfort in the apparent stability of this downturn, when hedging their investments, in the dollar's fortunes, if not its overall impact upon the fortunes of the United States' economy and goods sold abroad. (Schnaue, 2004)

Besides out-and-out hedging, two ways in which transactions exposure can be minimized are transferring exposure and netting transaction exposure. "The first of these is premised on transferring the transaction exposure to another company." (Kelly, 2001) An example of this would be when a U.S. exporting firm could quote the sales price of its product for sale in Germany in dollars. To avoid the German importer facing the transaction exposure resulting from uncertainty about the exchange rate, one means of transferring exposure would be to price the export in Deutsche Marks "but demand immediate payment, in which case the current spot rate will determine the dollar value of the export." (Kelly, 2001) Thus, the institution could minimize the risk of potential flux in the currency for the German firm, and encourage investment. This fixing of the rate could be accomplished either way, for both sides of the Atlantic, of course, depending on the needs of the company.

A second way in which transaction risk can be minimized is by 'netting out,' or diversifying in different markets and currencies. "This is especially important for larger companies that do frequent and sizeable amounts of foreign currency transactions. "Transaction…