International Financial Risks

Introduction

A company going international will face or encounter risks that are different from those faced in the home country. The risks in International transactions include foreign exchange risks and political risks.

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Foreign exchange involves things like currency shortages, depreciation, and increase of public debt or exchange rate fluctuations. Proper strategies should be adopted to cover this risk. If the risk is not well covered, it will affect the cash inflows and outflows and eventually profitability or even operations of an enterprise. Strategies adapted can be Strategic actions, operational tactics, and financial tactics.

Several instruments are used to cover this risk, although not available in all markets. Their availability in the market depends solely on the development of the economy in question, that is, financial infrastructure and services offered by the banks operating within it. Therefore, a risk management strategy requires one to be effective, have a good understanding of financial instruments and, above all, in emerging issues in the economy where you are investing. It is important to access these risks thoroughly, identifying the potential risks and assessing the strategy available to reduce them.

Exchange rates are influenced by several factors, including inflation rates, income levels, interest rates, government policies, expectations of economic events or changes, natural disasters or events and the effects of currencies fluctuations can have impacts at different levels.

Techniques for covering risk

  1. The balances to both intra-group and third party are matched. The companies match the inflows and outflows in different currencies covered by the business so that it is only necessary to deal on the currency markets for the unmatched proportion of the total transactions. It ensures that purchases and sales in each currency and deposits, given and taken in each currency, are in balance by the amount and by maturity.
  2. Leads and Lags: the acceleration or slowing payments or receipts when a change in currency rates is expected
  3. Invoicing currency: importers and exporters of goods and services charge in the currency at a favourable rate.
  4. Insurance: a company covers for a sudden change or total impasse in the availability of foreign currency on the maturity date.
  5. Futures: is a contract based on an order placed in advance to buy or sell an asset or commodity. The price will be fixed when the order is placed, but payment for the asset is not required until the delivery date. In this case, the buyer puts aside some cash as a form of assurance that he will pay or have the ability to pay when the time comes.
  6. Spot foreign exchange is a binding obligation to buy or sell a certain amount of currency at the current market rate for settlement in two business days
  7. Option is the right to purchase or to sell a certain asset at a preset price on or before a specified date.
  8. Swap is an agreement exchange specified assets or cash flows at fixed intervals, with the terms initially set so that its present value is zero
  9. Netting: involves associated companies that trade with each other and refers to potential flows within the group of companies. The companies calculate the total exposure by offsetting the receivables and payables, in the same currency, for the same dates

From the techniques discussed, the company will use almost all of the above since Australia has an active foreign exchange market.

Political risks

Some countries may experience major political instability, which could result in defaults on payments, exchange transfer blockages, nationalization or confiscation of property. The civil disorder may affect personal security. Unlike third world countries, Australia is a country with predictable political risks. There are very few political risks.

Foreign exchange settlement in Australia

In Australia, banks local and all foreign banks have decentralized their foreign exchange. However, some of the foreign banks have centralized foreign exchange settlement processes at their head offices, and therefore it takes a long period to settle the transaction. In such cases, the full financial and legal liability for foreign exchange settlement risk lies outside Australia, and most of these banks’ foreign exchange settlement risk was covered survey by G-10and reserve bank of Australia

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Risk being anything that threatens or limits the ability of a business to achieve its goal and objectives. Risk management is a process of thinking systematically about all possible undesirable outcomes before they happen and setting up procedures that will avoid them, minimize or cope with their impact. The in question should therefore plan how to cope with the discussed risks above.

References

Bachman, Daniel. 1992. “The Effect of Political Risk on the Forward Exchange Bias: The Case of Elections.” Journal of International Money and Finance 11:208-19.

Baillie, Richard T. and Patrick C. McMahon. 1989. The Foreign Exchange Market: Theory andEconometric Evidence. New York: Cambridge University Press.

Bernhard, William and David Leblang. 1998. “Political Uncertainty and Exchange Rate Volatility in Parliamentary Democracies.” Paper presented at the 1998 Meeting of the American Political Science Association, Boston, MA.

Christodoulakis, Nicos and Sarantis Kalyvitis. 1997. “Efficiency Testing Revisited: A Foreign Exchange Market with Bayesian Learning.” Journal of International Money and Finance16:367-85.

Fama, Eugene. 1984. “Forward and Spot Exchange Rates.” Journal of Monetary Economics 14:319-338.

Frederick S Choi; International Finance and Accounting Handbook; Wiley, 3003

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Freeman, John R., Jude C. Hayes and Helmut Stix. 1999. “Democracy and Markets: The Case of Exchange Rates.” Manuscript, University of Minnesota: Department of Political Science.

Garrett, Geoffrey. 1995. “Capital Mobility, Trade, and the Domestic Politics of Economic Policy.” International Organization 49(4):657-6

G. Poitras; Risk Management; Elsevier, 2002

Hallwood, C. Paul and Ronald MacDonald. 1994. International Money and Finance, Second Edition. Oxford: Basil Blackwell.

Hills, B. and D. Rule: “Counterparty credit risk in wholesale payment and settlement systems”. Financial Stability Review, no. 7, Bank of England,1999.

Hodrick, Robert. J. 1987. The Empirical Evidence on the Efficiency of Forward and Futures Foreign Exchange Markets. London: Harwood Academic Publishers.

Lewis, Karen. 1995. “Puzzles in International Financial Markets.” In G. Grossman and K.Rogoff (eds.), Handbook of International Economics, Volume III. Elsevier Science

MacDonald, Ronald and M. P. Taylor. 1991. “Testing Efficiency in the Interwar Foreign Exchange Market: A Multiple Time Series Approach.” Weltwirschaftliches Archiv 127:500-523.

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Mundell, R. 1961. “A Theory of Optimal Currency Areas.” American Economic Review 51:509

Peter Christofferson; Elements of Financial risk Management; Elsevier, 2003.

Peter C..Padoan P. C.; (2003) the Structural Foundations of International Finance; Edward E Pub.

Reserve Bank of Australia (1999): Reducing Foreign Exchange Settlement Risk in Australia . A Progress Report.

Reserve Bank of Australia (1997):Foreign Exchange Settlement Practices in Australia .

R. Luecke; Finance For Managers; Harvard Business School Press; 2002

Rolle, Richard and Shu Yan. 1998. “An Explanation of the Forward Premium ‘Puzzle.’” Manuscript, Los Angeles: The Anderson School at UCLA.

S. Carlson; International Financial Decisions; North Holland Pub; 1969.

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StudyCorgi. 2021. "International Financial Risks." August 31, 2021. https://studycorgi.com/international-financial-risks/.

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StudyCorgi. (2021) 'International Financial Risks'. 31 August.

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