4th unit

7/21/2019 4th unit

http://slidepdf.com/reader/full/4th-unit 1/74

7/21/2019 4th unit


RISK MANAGEMENT IN MULTINATIONAL CORPORATIONS

Concept of Risk

Risk is a condition where there is a possibility of an adverse deviation from a desired outcthat is expected or hoped for. The term risk may be defined as the “Possibility of adv

results flowing from any occurrence”. Risk arises out of uncertainty. When risk is said to e

there must always be at least two possible outcomes. !f it is "known for certain that a loss

occur there is no risk and at least one of the possible outcome is undesirable.

Types of Risk

#ollowing are the risks involved in multinational corporations$

"% Currency Risks: &urrency risk arises from a mismatch between the value of assets and

that of capital and liabilities denominated in foreign currency 'or vice versa), or because

of a mismatch between foreign receivables and foreign payables that are expressed in

domestic currency. (uch mismatches may exist between both principal and interest due.

The currency risks can be divided into three different categories$ transaction risk

translation risk and economic risk.

)% Politicl!Country Risks$ The political risk or in other sources called country risk is

explained as risks related to either the country of a foreign buyer or borrower or to a

third country which can cause the exporter financier or investor credit loss. Political

risks also include restrictions on transfer of the credit currency rescheduling of debts

expropriation and war or insurrection. The term political risk refers to all factors which

influence the country*s economy international relations and internal stability.

+% "inncil Risks: #inancial risk refers to the risks introduced in the profit stream by the

firm*s financial structure. The financial risks of foreign are not very different from those

of domestic operations.

,% !nterest Rate Risk$ !nterest rate risk refers to possible changes in cash flow or in the

value of assets and liabilities resulting from changes in interest rate.

-% &ommercial Risks$ Typical commercial risks include the buyer s guarantor*s or

borrower s unwillingness or insolvency to pay its debts. This kind of risk can also be

7/21/2019 4th unit


fails to meet its contractual obligations.

% Li#ui$ity Risk: /i0uidity risk refers to the possibility of the company s financial assets

proving that they are insufficient to cover its business needs or a situation in which

arranging such funding would result in additional cost.

Currency Risk

#oreign exchange 'currency% risk is the possibility of a gain or loss to a firm that occurs

due to unanticipated changes in exchange rate. #or example if an !ndian firm imports

goods and pays in foreign currency 'e.g. dollars% its outflow is in dollars thus it is

exposed to foreign exchange risk. !f the value of the foreign currency rises 'i.e. the

dollar appreciates% the !ndian firm has to pay more domestic currency to get the

re0uired amount of foreign currency.

&urrency risk results from changes in exchange rates between a bank*s domestic

currency and other currencies. !t originates from a mismatch when assets and

liabilities are valued in different currencies. That mismatch may cause a bank to

experience losses as a result of adverse exchange rate movements when the bank

has an open on1 or off1balance1sheet position either spot or forward in an

individual foreign currency. !n recent years a market environment with freely

floating exchange rates has practically become the global norm. This has 2 opened

the doors for speculative trading opportunities and increased currency risk. The

relaxation of exchange controls and the liberali3ation of cross1border capital

movements have fueled a tremendous growth in international financial markets.

The volume and growth of global foreign exchange trading has far exceeded the

growth of international and capital flows and has contributed to greater exchange

rate volatility and therefore currency risk.

&urrency risk is speculative and can therefore result in a gain or a loss depending

on the direction of exchange rate shifts and whether a bank is net long or net shortin the foreign currency. #or example in the case of a net long position in foreign

7/21/2019 4th unit


appreciation will produce a loss. 4nder a net short position exchange rate

movements will have the opposite effect.

!n principle the fluctuations in the value of domestic currency that create

currency risk result from changes in foreign and domestic interest rates that are

in turn brought about by differences in inflation. #luctuations such as these are

normally motivated by macroeconomic factors and are manifested over relatively

long periods of time although currency market sentiment can often accelerate

recognition of the trend. 5ther macroeconomic aspects that affect the domestic

currency value are the volume and direction of a country*s trade and capital

flows. (hort1term factors such as expected or unexpected political events

changed expectations on the part of market participants or speculation1based

currency trading may also give rise to currency changes. 6ll these factors can

affect the supply and demand for a currency and therefore the day1to1day

movements of the exchange rate in currency markets.

The general concept of foreign exchange exposure refers to the degree to which a

company is affected by the changes in the exchange rates. !n other words foreign

exchange exposure refers to the change in the exchange rate due to change in the

value of the assets liability and operating income either through their direct

relationship or through common underlying factors.

4sually foreign exchange risk and exposure are used interchangeably. !n fact

these two terms are different. The foreign exchange risk relates to the variabilityof domestic currency value of foreign currency denominated assets and liabilities

and foreign exchange exposure relates the sensitivity of foreign currency

denominated assets and liabilities to the unanticipated movements in exchange

rate.

%&'&(& Assess)ent!Mesure)ent of Currency Risk

6 crucial aspect in a firm*s exchange rate risk management decisions is the

measurement of these risks 7easuring currency risk may prove difficult atleast

7/21/2019 4th unit


with regards to translation and economic risk. 6t present a widely1used method is

the 8alue1at1Risk '8aR% model.

8alue at Risk 7odels

9roadly value at risk is defined as the maximum loss for a given exposure over a

given time hori3on with 3: confidence.

The 8aR methodology can be used to measure a variety of risk helping firms in

their risk management. ;owever the 8aR does not define what happens to the

exposure for the '"<< - z) % point of confidence i.e. the worst case scenario.

(ince the 8aR model does not define the maximum loss with "<< per centconfidence firms often set operational limits such as nominal amounts or stop

loss orders in addition to 8aR limits to reach the highest possible coverage.

The 8aR measure of exchange rate risk is used by firms to estimate the riskiness of

a foreign exchange position resulting from a firm*s activities including the foreign

exchange position of its treasury over a certain time period under normal

conditions.

The 8aR calculation depends on three parameters$

"% The holding period i.e. the length of time over which the foreign exchange positio

planned to be held.

The typical holding period is " day.

)% The confidence level at which the estimate is planned to be made. The

usual confidence levels are == per cent and =- per cent.

+% The unit of currency to be used for the denomination of the 8aR.

#or example a holding period of x days and a confidence level of y: the

8aR measures what will be the maximum loss 'i.e. the decrease in the

market value of a foreign exchange position% over x days if the x1days

period is not one of the '"<< > y%: x1days periods that are the worst under

normal conditions. Thus if the foreign exchange position has a "1day 8aR

of ?"< million at the =< per cent confidence level the firm should expect

7/21/2019 4th unit


that with a probability of == per cent the value of this position will

decrease by no more than ?"< million during " day provided that usual

conditions will prevail over that " day. !n other words the firm should

expect that the value of its foreign exchange rate position will decrease byno more than ?"< million on == out of "<< usual trading days or by more

than ?"< million on " out of every "<< usual trading days.

Clcultion of *lue t Risk Mo$els

To calculate the 8aR there exists a variety of models. 6mong them the more widely used

"% (imulation$ The historical simulation is the simplest method of calculation.

The historical simulation which assumes that currency returns on a firm*s

foreign exchange position will have the same distribution as they had in the

past. This involves running the firm*s current foreign exchange position

across a set of historical exchange rate changes to yield a distribution of

losses in the value of the foreign exchange position e.g. "<<< and then

computing a percentile 'the 8aR%.

Thus assuming a == per cent confidence level and a "1day holding period

the 8aR could be computed by sorting in ascending order the "<<< daily

losses and taking the """"" largest loss out of the "<<< 'since the confidence

level implies that " per cent of losses 1 "< losses 1 should .exceed the 8aR%.

The main benefit of this method is that it does not assume a normal

distribution of currency returns as it is well documented chat these returns

are not normal but rather leptokurtic. !ts shortcomings however are thatthis calculation re0uires a large database and is computationally intensive.

)% 8ariance1&ovariance 7odel$ The variance1covariance model which assumes

i% That currency returns on a firm*s total foreign exchange position are always

'@ointly% normally distributed and that the change in the value of the foreign

exchange position is linearly dependent on all currency returnsA and

ii% The currency returns are @ointly normally distributed. Thus for a == percentconfidence level the 8aR can be calculated as$

7/21/2019 4th unit


Where

8 p B !nitial value 'in currency units% of the foreign exchange position.

7 p B 7ean of the currency return on the firm*s total foreign exchange

position which is a weighted average of individual foreign exchange positions.

( p B (tandard deviation of the currency return on the firm*s total foreign

exchange position which is the standard deviation of the weighted

transformation of the variance1covariance matrix of individual foreign

exchange positions 'note that the latter includes the correlations of

individual foreign exchange positions%.While the variance1covariance model allows for a 0uick calculation its

drawbacks include the restrictive assumptions of a normal distribution of

currency returns and a linear combination of the total foreign exchange

position. Dote however that the normality assumption could be relaxed.

When a non1normal distribution is used the computational cost would be

higher due to the additional estimation of the confidence interval for the

loss exceeding the 8aR.

8 7onte &arlo (imulation$ 7onte &arlo simulation assumes that future

currency returns will be randomly distributed. 7onte &arlo simulation usually

involves Principal components of the analysis of the variance1 covariance

model followed by random simulation of the components. While its main

advantages include its

6bility to handle any underlying distribution and to more accurately measure the risk

other words a 7onte &arlo simulation refers to any method that randomly generates trial

by itself does not tell us anything about the underlying methodology.

Thus 8aR calculates the maximum loss expected 'or worst case scenario% on an

investment over a given time period and given a specified degree of confidence. We

looked at three methods commonly used to calculate 8aR. 9ut keep in mind that two of

our methods calculated a daily 8aR and the third method calculated monthly 8aR

7/21/2019 4th unit


%&'&'& Types of Currency Risk

There are mainly following types of currency risk$

%&'&+& Trnsction E,posure!Risk

Transaction exposure can be defined as “the sensitivity of reali3ed domestic currency

values of the firm*s contractual cash flows denominated in foreign currencies tounexpected exchange rate changes”. !n other words this exposure refers to the extent to

which the future value of firm2s domestic cash flow is affected by exchange rate

fluctuations. !t arises from the possibility of incurring foreign exchange gains or losses

on transaction already entered into and denominated in a foreign currency.

The degree of transaction exposure depends on the extent to which a firm2s transactions

are in foreign currency. #or example the transaction in exposure will be more if the

firm has more transactions in foreign currency.

#or example there is an !ndian importer of a machine who is to pay for imports after

the receipt of the machine in !ndia. This takes about thirty days to reach the !ndian sea

shore from the place of its export 'place of origin of exports%. !n these thirty days the

exchange rate changes thereby hurting the interest of the importer. (uppose the machine

is priced at ?"<<<<< and if at the time of contract the exchange rate is ?" BE +-.<< the

importer has. to pay exporter ?+-.<< F "<<<<< B E+-<<<<<. Dow if in the next thirty

days after which the machine is to arrive and the payment is re0uired to be made the

exchange rate moves to ?" B E+G.<< the importer will have to pay an extra amount of

XI,<<<<< 'E+G.<< x +-.<<% x "<<<<< extra because the exchange rate haH moved

adversely from ?" B E+-.<< to ?" B E+G.<<. With this change in exchange rate i.e. the

change in the price of dollar the importer has incurred a loss of E)<<<<< althoughA the

i f th hi i t f d ll h i d th i ?"<< <<<

7/21/2019 4th unit


%&'&%&I& Assess)ent!Mesure)ent of Trnsction E,posure

Transaction exposure measures gains or losses that arise from the settlement of existing

financial obligation whose terms are stated in a foreign currency. Two steps are

involved in measuring transactions exposure."% Ietermine the pro@ected net amount of currency inflows or outflows in each for

currencyA

)% Ietermine the overall exposure to those currencies.

The first step in transaction exposure is the pro@ection of the consolidated net amount of

currency inflows or outflows for all subsidiaries classified by currency subsidiary.

(ubsidiary 6 may have net inflows of ?<<<<< while subsidiary 9 may have net

outflows of ?G<<<<<. The consolidated net inflows here would be 1 ?"<<<<<. !f the

other currency depreciates subsidiary 6 will be adversely affected while subsidiary 9

will be favorably affected. The net effect of the dollars depreciation on the 7D&s is

minor since an offsetting effect takes place. !t could have been substantial if most

subsidiaries of the 7D&s had future inflows of 4( dollars. Thus while assessing the

7D&s exposure it is advisable as a first step to determine the 7D&s overall 1position

in each currency.

7/21/2019 4th unit


)% Te)porl Met-o$: The temporal method can be defined as a method of translating

foreign currency through the use of exchange rates based on the time of ac0uisition of

assets and liabilities. The exchange rate involved also depends on the valuation

method being used. #or assets and liabilities valued at current costs the currentexchange rate is used. 5n the contrary the assets valued at historical costs involve the

use of historical exchange rates.

9y using the temporal method any income1generating assets like inventory property

plant and e0uipment are regularly updated to reflect their market values. The gains

and losses that result from translation are placed directly into the current consolidated

income. This causes the consolidate earnings to be rather volatile.

7/21/2019 4th unit


&urrent Rale 7ethod$ The current rale method is the simplest and the most

popular method ail over the world. 4nder this method all balance sheet and income1

items are translated at the current rate of exchange except for stockholder*s e0uity.

!ncome statement items including depreciation and cost of goods sold are translated

at either the actual exchange rate on the dates the various revenues and expenses wereincurred or at the weighted average exchange rale for the period. Iividends paid arc

translated at the exchange rate prevailing on the date the payment was made. The

common stock account and paid1in1capital accounts are translated at historical rates.

#urther gains or losses caused by translation ad@ustment are not included in the net

income but arc reported separately and accumulated in a separate e0uity account

known as &umulative Translation 6d@ustment '&T6%. Titus &T6 account helps in balancing the balance sheet balance since translation gains or losses are not ad@usted

through the income statement.

The two main advantages of the current rate method are first the relative proportion

of the individual balance sheet accounts remain the same and hence do not distort th

various balance sheet ratios like the debt1e0uity ratio current ratio .etc. (econd th

variability in reported earnings due to foreign exchange gains or losses is eliminated as th

translation gain J loss is shown in a separate account > the &T6 account the ma

+% &urrent and Don &urrent 7ethod$ !n this method all current assets and

liabilities are translated into domestic currency at current exchange rate.

Kach non1current item is translated at historical exchange rate 'i.e. at the

rate when it was purchased%. Thus in this method the cash and working

capital of a subsidiary after appreciation of the parent*s currency is going to

give translation losses and its appreciation will provide translation profits.

!n this method income statement is translated at average exchange rate of the

period except those receivables and payables associated with non1current

assets and liabilities. The later items such as depreciation are translated at the

same exchange rates as the corresponding balance1sheet items.

7/21/2019 4th unit


recorded at historical costs are translated back into dollars at a different rate.

Mn.e)ent of Trnsltion E,posure

#ollowing methods arc used to hedge translation exposure$

"% ;edging Through #und 6d@ustment$ The fund ad@ustment involves altering the levels

amounts in various currencies or changing currency denomination of assets with

liabilities. Ievaluation of subsidiary2s currency reduces assets in terms of foreign currenc

and liabilities increase in terms of local currency. !f foreign exchange exposure is to b

reduced asset should be converted to hard currencies and liabilities into soft currencies.

Iirect fund ad@ustment includes pricing export in hard currencies and imports in loc

currencies replace hard currency borrowings by local currency borrowings.The indirect fund ad@ustment is through transfer pricing speeding of payments of dividend fe

and royalties ad@ustment of flow of funds through leading and lagging.

6s such the transfer pricing decision fees royalty flows and dividend flow ad@ustment fa

linger the purview of corporate policy and are not under the treasurer2s control therefore it

the duty of the treasurer to inform management about the impending effects of exchange ra

movement and suggest strategy to hedge their payments.

)% Kntering !nto #orward &ontract ;edge$ #orward contract can reduce a firm2s translatio

exposure by creating an offsetting asset or liability in the foreign currency. 6ny loss or ga

on its translation exposure will then be offset by a corresponding gain or loss on its forwa

contract.

The gain or loss on the forward contract is of a cash flow nature and is netted against unreali3e

translation loss or gain.

(ometimes the c rrenc to be hedged ith for ard contract ma not be 0 oted in the for ar

7/21/2019 4th unit


market then the hedging can be done through a proxy currency having high correlation with th

currency to be hedged. This hedge will not be a perfect one as it depends on the degree o

association between the movements of two currencies.

Kxposure Detting$ Detting reduces the cost of transaction this is possible only when

organi3ation is operating in a multi1subsidiary and multi1currency environment. Kven in the

of a party L importing and exporting to the same country the receivables and payables ca

netted and the balance can be hedged by a forward future or option contract.

,% 5ther 7ethods$ The other methods worth considering are leading and lagging

payables and receivables. These two methods are used fre0uently because there is

a continuous flow of funds between subsidiaries and parent. !f parent2s currency is

expected to appreciate against the currency of the subsidiaries the receivable

should be lead and if it is expected to depreciate against the currencies of the

subsidiaries the receivables should be lagged.

Accountin. Stn$r$s for Trnsltion E,posure in In$i

This first official ruling eliminated much of the flexibility that 4.(.1based

multinational corporations previously had in translating their foreign affiliates*

financial statements into reference currency. The mandatory translation guidelines

put forward by #6(9 (tatement M which were implemented for the first time in

"=G closely approximate those advocated by the monetaryJnon1monetary

method. ;owever #6(9 statement M takes a closer look at the nature of each

balance sheet item and provides specific rules for the translation treatment of each

account.

The most dramatic conse0uence of #6(9 (tatement M is that exchange gains or

losses resulting from both the conversion and translation process are to be included

in the net income for the accounting period in which the exchange rate change

actually occurred. The #6(9 une0uivocally re@ected the distinction between

reali3ed and unreali3ed exchange gains or losses as well as other income1

smoothing devices that resulted in the deferral or amorti3ation of exchange gains

7/21/2019 4th unit


the periodic income of multinational corporations that allowed themselves to incur

significant translation gains and losses. 4nder pressure from publicly listed

multinational corporations a new statement #6(9 no. -) replaced (tatement no.

M in Iecember "=M".

"inncil Accountin. Stn$r$s /or$ Stte)ent 0'

The accounting profession has recogni3ed the growing importance of foreign1

currency transactions andJor foreign operations. !n 5ctober "=G- the #inancial

6ccounting (tandards 9oard '#6(9% issued its (tatement M 6ccounting for the

Translation of #oreign &urrency Transactions and #oreign &urrency #inancial

(tatements. #6(9 M formerly re0uired 4.(. companies to translate their foreign1

currency financial statements into dollars by applying the appropriate exchange rate

to the measurement basis of each accountA the appropriate exchange rate may be the

historical rate the current rate or the average rate. This statement also re0uires

companies to show all foreign1exchange gains or losses in their 0uarterly and

annual income statements regardless of whether these gains or losses were reali3ed

or unreali3ed.

#6(9 M was a product of considerable effort including extensive exposure drafts

and discussion memoranda by the #6(9 to resolve the translation issue. ;owever

from its inception in autumn "=G- #6(9 M was the sub@ect of extensive debateA

most of the criticism centered on recogni3ing foreign1exchange gains or losses.

&ompanies claimed that #6(9 M grossly distorted their earnings because of the

sharp fluctuations in foreign1 exchange rates. The #6(9 issued its (tatement -)

#oreign &urrency Translation on Iecember G "=M". #6(9 -) supersedes #6(9 M.

!n "=M) 4.(. companies were allowed to utili3e either #6(9 M or #6(9 -). #ord

used #6(9 -) in "=M) to exclude its translation loss of about ?))< million from the

income statement. !n the same year Neneral 7otors employed #6(9 M to include

its translation gain of about ?+M, million in the income statement.

#6(9 -) re0uires the use of the current exchange rate in translating foreign1

7/21/2019 4th unit


placed directly in stockholders* e0uity rather than income. Thus #6(9 -) has

substantially reduced fluctuations in many companies* reported earnings caused by

gyrations in foreign1exchange rates under #6(9 M.

!n this section two terms are extensively used 1 parent currency and functional

currency. Parent currency sometimes called reporting currency is the currency of

the country where the parent company is located. #or example the parent currency

of 4.(. based 7D&s is the dollar. The functional currency usually called foreign

currency or local currency is the currency of the country where the foreign

operation of an 7D& is located.

7/21/2019 4th unit


The functional currency of an entity as defined in #6(9 -) 'paragraph +=% is “th

currency of the primary economic environment in which the entity operatesA normally tha

is the currency of the environment in which an entity primarily generates and expend

cash”.

The term “functional currencyO was first used in the translation literature in con@unctio

with #6(9 -). #unctional currency is in fact a key feature of #6(9 -) because i

determines tire choice of translation method. This feature is very important because th

translation method employed determines the translation rate and the disposition o

exchange gains and losses. !f the foreign currency is determined to be 'he functiona

currency #6(9 -) is used to carry1out the translation process. 5n the other hand if th

4.(. dollar is deemed to be the functional currency #6(9 M is used to re1measure foreign

currency operations in dollars.

Mec-nics of "AS/ 0' Trnsltion Process

The actual translation process prescribed by #6(9 -) is a two1stage process. #irst

it is necessary to determine in which currency the foreign entity keeps its books. !f the

local currency in which the foreign entity keeps its books is not the functional currency re

measurement into the functional currency is re0uired. Re1measurement is intended “t

produce the same result as if the entity*s books had been maintained in the functiona

currency”. The temporal method of translation is used to accomplish the re1measurement.

5nce the functional currency is determined a firm can begin its process of translating

statements under #6(9 -) and consolidating or combining the results of disparat

operations. The use of either the current or the temporal rate is determined by the location

of operations and resulting functional currency. !f the books and records are kept in th

currency of the parent no restatement is necessary. !f however the books and records ar

kept in a local currency the subsidiary has three different translation routes depending on

the functional currency.

!f the functional currency is the local currency of the subsidiary the parent merel

l h i 4 ( d ll i h h d Thi i i

7/21/2019 4th unit


holds unless the functional currency is a local currency in a high1inflation country in

which case the firm must use the temporal method of translation. ;igh1 inflation countrie

arc defined as those with inflation rates greater than "<< per cent for three consecutiv

years.

!f the functional currency is the parents* home currency even if the books are kept in the

local currency the firm uses the temporal method to re1measure results. !f the functiona

currency is a third currency 'the firm re1measures from the local to the functional currenc

using the temporal method and then translates the result into the home currency using th

current1rate method.

Econo)ic E,posure!Risk

5perating exposure is a relatively broader conception of foreign exchang

exposure. The prime feature of operating exposure is that it is essentially a long1term

multi1transaction1oriented way of looking at the foreign exchange exposure of a firm

involved in international business. The standard definition of economic exposure is th

degree to which fluctuations in exchange rates will affect the net present value of th

future cash flows of a company. 5perating exposure is also known as economic exposure.

5perating exposure is a particularly serious problem for multinational corporation

with operations in several different countries. (ince currency fluctuations do not follow

any set pattern each operation is sub@ect to a different degree and nature of economi

exposure. 7easuring the degree of economic exposure is even more difficult tha

measuring translation exposure. Kconomic exposure involves operational variables sucas costs prices sales and profits and each of these is also sub@ect to fluctuation in value

independent of the exchange1 rate movements. 7any techni0ues are used to measur

economic exposure. 7ost of these techni0ues rely on complex mathematical and statistica

models that attempt to capture all the variables. 4se of regression analysis and simulatio

of cashflow positions under different exchange1rate scenarios are two examples of suc

techni0ues.

5perating exposure is the risk that a company*s cashflow foreign investments an

7/21/2019 4th unit


earnings may suffer as a result of fluctuating foreign currency exchange rates.

7/21/2019 4th unit


5perating exposure refers to the changes in expected cashflow due to unexpected

movement in the exchange rate. !t refers to the extent to which the economic value of a

company can decline due to movement in the exchange rate.

Assess)ent!Mesure)ent of Kconomic Kxposure

The degree of economic exposure to exchange rate fluctuations is significantly

higher for a firm involved in international business than for a purely domestic firm.

6ssessing the operating exposure of 7D&s is difficult due to the complex interaction of

funds that flow intoA out of and within the 7D&s. 5perating exposure is crucial to

operations of the firm in the long1run. !f an 7D& has subsidiaries around the world each

subsidiary will be affected differently by fluctuations in currencies. Thus attempts by the

7D&s to measure its economic exposure would be extremely complex.

5ne method of measuring a 7D&s operating exposure is to classify the cash flows into

different items on the income statement and predict movement of each item in the income

statement based on a forecast of exchange rates. This will help in developing an alternative

exchange rate scenario and the forecasts for the income statement items can be revised. 9yassessing how the earnings forecast in the income statement has changed in response to

alternative exchange rate scenarios the firm can assess the influence of currency

movements on earnings and cash flows.

&urrency risk or uncertainty which represents random changes in exchange rates is not

the same as the currency exposure which measures “what is at risk.” 4nder certain

conditions a firm may not face any exposure at all i.c. nothing is at risk even if the

exchange rates change randomly. (uppose a businessman company maintains a vacation

home for employees in the 9ritish countryside and the local price of this property is always

moving together with the pound price of the 4.(. dollar. 6s a result whenever the pound

depreciates against the dollar the local currency price of this property goes up by the same

proportion. !n this case the businessman company is not exposed to currency risk even if

the poundJdollar exchange rate fluctuates randomly. The 9ritish asset your company owns

has an embedded hedge against exchange risk rendering the dollar price of the asset

7/21/2019 4th unit


insensitive to exchange rate changes.

&onsider an alternative situation in which the local 'pound% price of your company*s

9ritish asset barely changes. !n this case the dollar value of the asset will be highly

sensitive to the exchange rate since the former will change as the latter does. To the

extent that the dollar price of the 9ritish asset exhibits “sensitivity” to exchange rate

movements your company is exposed to currency risk. (imilarly if the businessmancompany*s operating cashflows are sensitive to exchange rate changes the company is

again exposed to currency risk.

Kxposure to currency risk thus can be properly measured by

the sensitivities of$

". The future home currency values of the firm*s

assets'and liabilities% and

). The firm*s operating cashflows to random changes in

exchange rates.

Mn.e)ent of Econo)ic E,posure

Transaction exposure is short1term in nature and well1identified. 5perating

exposure on the other hand is long1term in nature and can scarcely be

identified with precision. (o the instruments of financial hedging 'forwards

7/21/2019 4th unit


options and so on% which are helpful in hedging short1term well1identified

transaction exposure are not of much help in hedging operating exposure.

7anaging operating exposure calls for designing the firm2s marketing

production and financing strategy to protect the firm2s earning power in the

wake of exchange rate fluctuations.

The following are some of the proactive marketing and production strategies

which a firm can pursue in response to anticipated or 2actual real exchange rate

changes$

"% "inncil Strte.y$ The hedging techni0ues used for the transaction

exposure especially those that are used for long1term transaction exposure

are also used for managing real operating exposure. ;owever they are of

little use in this case because the effects of currency changes on the

expected cashflows are hard to predict. !t is therefore better to use

sophisticated computeri3ed tools for this purpose. Devertheless while

developing a financial strategy the finance manager has to see that the

firm*s liabilities during the application of marketing and production

strategies are so structured that they can be matched to a reduction in

assets* earnings during that period. This means that if assets* earnings drop

the servicing burden of liabilities too should be lower and assets and

liabilities are re1structured to this end.

)%Mrketin. Strte.y$ !t includes among other things selection of market

product planning and pricing policy. The policy in this respect is influenced

by the geography of the market dominance of the firm in the international

market and the elasticity of demand for the product. The policy is re1

designed when there is change in the value of domestic currency or

importers* currency or that of competing countries$

i% Mrket Selection$ !f the firm is an exporter and if the domestic currency

appreciates or if the currency of the importing country or competing

7/21/2019 4th unit


of price. The strategy in this case should be to pull out of the existing

market and to develop new markets and market segmentation within a

particular importing country may be adopted. !f the product is demanded

more by the affluent class of consumers the appreciation of domestic

currency may not matter much. The strategy should therefore be to

concentrate on this class of consumers. 6gain if the firm is a dominant

supplier of the product or if the price1elasticity of demand for the product is

low the firm can stick to the existing market without making changes in

price.

ii% Pro$uct Plnnin.$ The firm can respond to changes in exchange rate through

modifying its product strategy. !t can innovate and introduce a new product

or bring modification in the features of the existing product meaning that it

can introduce a new variety of the existing product. The greatest advantage

of an innovated product is that it generates demand among consumers. !f

appreciation of the home currency leads to a drop in export of the existing

product an innovated product may fill this gap.

iii% Pricin. Policy$ !t includes raising or lowering of price of the product

following the exchange rate changes. (uppose the dollar appreciates fromE

+- to E,). 6n 6merican company selling its product in !ndia and printing

the price of the product in rupees at EG< will face shrinkage in its profit in

dollar terms. !f the company likes to maintain its profit it will have to raise

the price to EM,. 9ut in that case demand for the product will diminish

especially when

iv% there is competition from local suppliers. !n this case the firm will have to

satisfy itself with the lower profit.

5n the other hand if the dollar depreciates from E,< to E+- the selling

price of the 6merican product at EM< may easily be cut to EG< without

reducing the profit margin in dollar terms. Rather the lowering of the

i d i ill i i d d d h b i h l f l f

7/21/2019 4th unit


the printed price is not changed the profit margin shall increase. Thus it is

an important decision between increase of profit per unit and increase in the

market share and the total revenue. !n fact such a decision depends upon

price elasticity of demand economies of scale cost structure of expanding

output and the likelihood of competition etc. #or example if economies of

scale are obvious holding down of prices would be a better course of

action. 6gain when there is no competition there will be no pressure from

any 0uarter to cut down the price. Prices can be raised when the product is a

differentiated one.

+% Pro$uction Strte.y$ The production strategy concentrates primarily on the following$

i% Pro$uct Sources$ !f the currency of the country supplying inputs appreciates the

input1buying firm has to find some other sources of supply that may be cheaper. !f

the home currency appreciates it would be in the interest of the input1buying firm

not to change the source of supply and preferably to buy input from the countries to

which it exports its final product because then its terms of trade will improve. This

step would be highly beneficial if the imported inputs account for a large part of the

total inputs. 6gain it is not only the cost of material that counts but also the cost of

labour. !t is for this reason that 7D&s head0uartered in the developed countries

procure their labour1intensive inputs from developing countries where labour is

cheap and set up their labour1intensive assembly units in the developing countries.

(ometimes the strategy begins with establishing multiple sources of inputs. This is

to save the foreign exchange to be spent on importing inputs from an appreciating1

currency country.

ii% Input Mi,in.$ !f a firm is unable to buy cheaper inputs from any source it can arrest

rise in the cost of production through mixing local inputs which may be cheaper.

This re0uires expenditure on research and development so that a new technology

using cheaper inputs in a greater proportion can be evolved. To arrive at the correct

course of action the benefit of input1mixing must be weighed against the cost of

research and development

7/21/2019 4th unit


iii% Plnt Loction$ 6lternatively the firm can locate its plant in a country whose

currency has depreciated provided that the inputs are available there. !n a case

where inputs are available only in one particular country the firm will have to

import them even if the currency of the input1supplying country appreciates.

There are thus different options open for improving the future cost1revenue streams.

6 firm chooses any one of them or a combination of more than one options

depending upon the re0uirements of each case.

7/21/2019 4th unit


Trnsction E,posure versus Econo)ic E,posure

9asis of Iifferences Transaction Kxposure Kconomic Kxposure

"% 7eaning

Transaction exposure is an uncertaindomestic currency value of a cashflow which is known and fixed inforeign currency termA for example aforeign currency receivable.

Kconomic exposure is an uncertaindomestic currency value of a cash flowwhose value is uncertain even inforeign currency termsA for examplecash flows from a foreign subsidiary.

)% Dature &ontact specific. !t relates to the entire investment.

+% &omputation of /osses

&ash flow losses due to an exchangerate change are easy to compute.

(imple financial accountingtechni0ues can be used to computelosses due to transaction exposure.

5pportunity losses caused by anexchange rate change are difficult tocompute. 6 good variance accounting is

needed to isolate the effect of exchangerate change on sales volume costs and profit margins.

,% Policies #irms generally have some policies tocope with transaction exposure.

#irms generally do not have policies tocope with economic exposure.

-% 6voidance Re0uires 6voidance sometimes re0uires third1 party cooperation 'for examplechan in invoice currenc .

6voidance re0uires good strategic planning 'for example choice omarkets roducts etc.

% Iuration of Kxposure The duration of exposure is the sameas the time period of the contract.

The duration of exposure is the timere0uired for the restructuring ooperations through such means as

changing products markets sourcesand technolo .G% Relationship

Relates to nominal contracts whosevalue is fixed in foreign currencyterms.

Relates to cash flow effects throughchanges in cost price and volumerelationships.

M%(ources of 4ncertaintiesThe only source of uncertainty is thefuture exchange rate.

The many sources of uncertaintiesinclude the future exchange rate and its

effect on sales price and costs.

9asis o Translation J6ccountin Kx osure Kconomic Kx osure"% 5ccurrences 5ccurs only when an 7D& has foreign

subsidiaries.

5ccurs for any type of foreign

operations.

)% &oncept 6 backward looking concept. !t reflects

past decisions as reported in the

subsidiar *s financial statements.

6 forward looking concept. !t focuses on

future cashflows.

+% Iealing Ieals with accounting values due to

translation.

Ieal with cashflows 'not @ust accounting

values% and market value of the 7D&.

,% (ub@ect 7atter (ub@ect to accounting rules and

regulations.

(ub@ect to economic facts such as

outstanding commitments denominated

in foreign currency and operating

exposure.(% &onsideration

/ k l i h fi i l

!ncorporates all cashflows and sources of

7/21/2019 4th unit


%&'&1& Trnsltion E,posure 2ersus Econo)ic E,posure

Country Risk Anlysis

Intro$uction

6 collection of risks associated with investing in a foreign country includes

political risk exchange1rate risk economic risk sovereign risk and transfer risk

which is the risk of capital being locked up or fro3en by government action.

&ountry risk is a broader concept than political risk or sovereign risk. &ountry risk

varies from one country to the next. (ome countries have high risk enough to

discourage much foreign investment. &ountry risk can reduce the expected return

on an investment and must be taken into consideration whenever investing abroad.

(ome country risk does not have an effective hedge. 5ther risk such as exchange

rate risk can be protected against with a marginal loss of profit potential.

&ountry risk refers to uncertainties or potential risk related to investing in or

loaning to different countries in international business. There are various reasons

that might change the capability and willingness of a country to repay its

international debt. #or example higher taxes or tariffs limited currency

conversion inflation and currency depreciation economic recession workers

striking war etc. These potential risks make investment in the country less

profitable even losing money as investors may not get their repayments on time.

Tec-ni#ues to Assess Country Risk The techni0ues to assess country risk mainly try and identify certain key

economic political and financial variables including a country*s economic growth

rate its current account balance relative to gross domestic product and various

ratios 1 debt to NIP debt1service payments to NIP savings to investment interest

payments to NIP etc. These ratios mainly try and find out directly or indirectly a

country*s ability to repay its external financial obligations on schedule. 6lso the broad parameters identified help to expose the basic strengths and weaknesses of a

7/21/2019 4th unit


country. /isted below are some of the more popular indicators to assess country

risk$

"% 3e4t Relte$ "ctors$ The debt related factors are the 0uickest and commonest

variables employed to test the possibility of a country defaulting due to debt. To

predict the risk of default there are two different theoretical approaches. 5ne

approach regards default as arising out of an unintended deterioration in the

borrowing country*s capacity to service its debt. The other approach views the

probability of default of external debt as an international decision made by the

borrower based on an assessment of the costs and benefits of rescheduling.

Iifficulties in debt servicing could be a result of short1term li0uidity problems or

could be attributed to long1term insolvency problems.

The debt service indicators include$

7/21/2019 4th unit


i% !nterest paymentsJ#oreign exchange receipts 'li0uidity%.

ii% Iebt1service ratio 'relates debt service re0uirements to export incomes%.

iii% (hort1term debtJ Total exports.iv% !mportsJNIP 'sensitivity of domestic economy to external development%.

v% #oreign public debtJNDP 'relates external debt to country*s wealth%.

vi% /evel of net disbursed external debtJNDP.

vii%Det disbursed external debtJKxport of goods and services.

viii% Det interest paymentJKxports of goods and services.

ix% &urrent account balance on Nross Det Product 'countries with large currentaccount deficit are usually less creditworthy%.

)% /lnce of Py)ents$ The fundamental determinate of a country*s vulnerability is its

balance of payment. The balance of payments management is a function of among

other things internal goals and changing external circumstances.

x% 6 very useful indicator of country risk analysis is the current account balance.

!t summari3es the country*s total transactions with the rest of the world for goods

and services 'plus unilateral transfers% and represents the difference between

national income and expenditure. !t also indicates the rate at which a country is

building foreign assets or accumulating foreign liabilities.

xi% The balance of payment indicators include$

i% Percentage increase in importsJPercentage increase in Nross Iomestic Product

'this ratio shows the income elasticity of demand for exports%.

ii% #oreign income elasticity of demand for the exports.

iii% 4nder or overvaluation of the exchange rate on a purchasing power parity basis.

iv% &urrent 6ccountJNDP 'a measure of the country*s net external borrowings relative

to country si3e%.

v% Kffective Kxchange Rate !ndex 'measures the relative movements in domestic and

international prices%.

vi% !mports of goods and servicesJNIP.

7/21/2019 4th unit


vii%Don1essential consumer goods and servicesJTotal imports.

viii% Kxports to "<1"- main customersJTotal exports.

ix% Kxports of "<1"- main itemsJTotal exports.x% Kxternal reservesJimports.

xi% Reserves as : of imports 'goods and services%. 0

xii%Kxports as : of imports 'goods and services%.

+% Econo)ic Perfor)nce$ Kconomic performance can be measured in terms of a

country*s rate of growth and its rate of inflation. The inflation rate can be regarded

as a proxy for the 0uality of economic management. Thus the higher the inflation

rate the lower the creditworthiness rating. The economic performance can be

measured by a set of ratios that focus on the long1term growth prospects and any

economic imbalances of the economy.

xii% The significant ratios that can be used to measure economic performance are$

i% Nross Dational 'or domestic% Product per capita 'this ratio measures the level of

development of a country%.

ii% Nross investmentJNross Iomestic Product. 'This ratio is called the propensity to

invest ratio and captures a country*s prospects for future growth. The higher the

ratio the higher the potential economic growth%.

iii% !nflation '&hange in consumer prices as an annual average in :. This measures

the 0uality of economic policy%.

iv% 7oney supply 'serves as an early indicator for future inflation%.v% Noss Iomestic (avingsJNross Dational Product.

xiii% Politicl Inst4ility$ There have been several occasions when sovereign

borrowers with the capacity to service their external debts have defaulted for purely

political reasons. Political instability undermines the economic capacity of a

country to service its debt. Political instability has both direct effect and an indirect

effect on the credit rating of a country. The direct effect of political instability on

debt service problems emerges in the form of unwillingness rather than an inability

7/21/2019 4th unit


to service the debt.

xiv% The political instability indicators which can be considered are$

i% The political protest for example protest demonstrations political strikes riots

political assassination etc.

ii% (uccessful and unsuccessful irregular transfer e.g. coup attempt etc.

xv%-% C-ecklist Approc-$ 6 number of relevant indicators that contribute to a firm*s

assessment of country risk are chosen and a weight is attached to each. 6ll aspects

of risk arc summari3ed in a single country rating that can be readily integrated into

the decision making process. #actors having greater influence on country risk are

assigned greater weights.

xvi% The weighted checklist approach employs a combination of statistical

and @udgmental factors. (tatistical factors try and assess the performance of a

country*s economy in the recent past in the expectation that this will provide an

insight into the future. These factors can be compiled relatively easily.

xvii% The analyst can choose from a wide range of statistical factorsA rapid

rise in production costs interest1 service ratio real NIP growth debtJNIP

importsJreserves foreign exchange receipt exportJNIP ratio importJNIP etc.

xviii% I)portnce of Country Risk Anlysis

xix% &ountry risk is the potentially adverse impact of a country*s

environment on an 7D&*s cash flows. &ountry risk analysis can be used to monitor

countries where the 7D& is currently doing business. !f the country risk level of a

particular country begins to increase the 7D& may consider divesting its subsidiaries

located there. 7D&s can also use country risk analysis as a screening device to avoid

conducting business in countries with excessive risk. Kvents that heighten country risk

tend to discourage direct foreign investment in that particular country.

xx% &ountry risk analysis is not restricted to predict ma@or crises. 6n 7D&

may also use this analysis to revise its investment or financing decisions in light of

7/21/2019 4th unit


recent events. !n any given week the following unrelated international events naight

occur around the world$

"% 6 terrorist attack.)% 6 ma@or labor strike in an industry.

+% 6 political crisis due to a scandal within a country.

,% &oncern about a country*s banking system that may cause a ma@or outflow of

funds.

-% The imposition of trade restrictions on imports.

xxi% 6ny of these events could affect the potential cashflows to be generated by an

7D& or the cost of financing pro@ects and therefore affect the value of the 7D&.

xxii% Kven if an 7D& reduces its exposure to all such events in a given week a new

set of events will occur in the following week. #or each of these events an 7D& must

consider whether its cashflows will be affected and whether there hay been a change ip

policy to which it should respond. &ountry risk analysis is an ongoing process.

xxiii% 7ost 7D&s will not be affected by every event but they will pay close

attention to any events that may have an impact on the industries or countries in which

they do business. They also recogni3e that they cannot eliminate their exposure to all

events but may atleast attempt to limit their exposure to any single country1 specific

event.

xxiv% Politicl Risk xxv% Political risk is defined as the whole of decisions conditions or events

of political nature able to trigger directly or indirectly a financial loss or a physical

damage for an investment pro@ect fn other words this is the risk of incurring losses

when investing in a foreign country as a result of changes in the country2s political

structure or policies such as tax laws tariffs expropriation of assets restriction in

repatriation of profits or episodes of political violence. #or example a company may

suffer such losses in the case of expropriation tightened foreign exchange repatriation

7/21/2019 4th unit


rules or social turmoil.

xxvi% Political risk is the risk that results from political changes or instability in a

country. !t has adverse impact on the working of foreign enterprises located in that

country as well as on financial and commercial operations carried out with such a

country. This kind of risk becomes more pronounced when factors of instability such

as wars riots social and religious conflicts or nationalist movements crop up. #rom

an economic viewpoint political risk refers to uncertainty over property rights.

xxvii% 6ccording to 6gmon defines “political risk as the unanticipated changes in

political factors that affect the relative prices of traded factors of production goods and

services caused by the actions and reactions of governments and other political groups

within and between countries”.

xxviii% The ma@or political risk concerns of foreign investors could be viewed as

follows$

"% (tability of local economy and absence of high inflation.

)% #air and e0ual treatment from the host government

+% #reedom from arbitrary and changing government regulation.

,% #ree transfer of profit from the host country.

-% 6bility to sell or li0uidate investment and subse0uently to withdraw funds from the

country and

% The political willingness and ability to make structural reforms.

xxix% !n general there are two types of political risk macro risk and micro risk.

(u3uki is the good example of political risk which faced considerable hostility from

the !ndian government in the late "==<s.

xxx% #or example Tata Dano pro@ect in (ingur faced the political backlash when

fanners protested against forceful takeover of ,<< acres of agricultural land for the pro@ect by West 9engal government. Trinomial party supported the farmers played

7/21/2019 4th unit


hardball and Ratan Tata took a decision to shift the pro@ect from West 9engal to

Nu@arat. 5ne states loss was another states gain.

xxxi% Types of Politicl Risk xxxii% #ollowing are the types of political risk$

xxxiii)

xxxiv% Micro Politicl Risk: 7acro risk is a type of political risk companies face

when conducting operations in foreign countries. 7acro risk refers to adverse actions

that will affect all foreign firms such as expropriation or insurrection. 6 macro

political risk affects all international businesses in the same way. Kx1propriation the

sei3ure of assets by government with little or no compensation to the owners is a

macro political risk. &omrfiunist governments in Kastern Kurope and &hina

expropriated private firms following World War !!.

xxxv% These potentially affect all businesses in a country. Threats may arise from dramatic

actions such as terrorism civil war a coup detat or military insurgence. (uch risks may

result in governments sei3ing the assets of the firm without compensation. ;owever the

more common macro1political risk specific to a country is the potential threat of adverse

economic circumstances leaving a business unsure of the security of a planned future

investment or if a pro@ect has commenced concerned over the out1turn bottom1line

performance. 6n example of an adverse threat is economic recession with less aggregate

demand for a broad range of products. (imilarly higher general levels of inflation or taxation might

adversely affect all businesses as might escalating crime labour disputes or the onset of a national

recession.

xxxvi% 7acro Risksxxxvii%11111111111 111111111111111111111 11111111 2

xxxviii% !mpact

xxxix% "% Kxpropriation of corporate assetswithout prompt and ade0uate

xl% /oss of future profits

xli%)% 9arriers to repatriation of profits xlii% Do motivation to improve efficiencyxliii% +% &onfiscation of properties xliv% /oss of assets and future profitsx v , /oss o tec no ogy or ot er l i% / f f t fit

i)

7/21/2019 4th unit


xlvii% -% &ampaigns against foreign goods xlviii% /oss of sales and increased costs of publicrelations campaigns

xlix% 5 7andatory labour legislations2 Q l% !ncreased operating costsli% G% &ivil wars lii% Iestruction of property loss of sales increased

security costs disrupted production runsliii% M% !nflation liv% !ncreased operating costslv% =% &urrency devaluations lvi% Reduced values of repatriated earnings

lvii%

lviii%

lix%

)% Micro Politicl Risk $ 6 micro political risk affects specific foreign business. 7icro

political risks include industry regulations taxes kidnapping and terrorist threats.

!ndia2s decision in "=G- to reduce foreign e0uity to ,< percent and Peru2s decision

to nationali3e its copper mines are examples of micro political risks. The 4(

decision to tax textile imports is another.

lx% #irms which have high visibility in host countries are targets pf micro political

risk. !f agitations are caused by animosity between factions in the host country and

the government of a foreign country agitators may target only the most visible

companies from that foreign country like #&.

lxi% 7icro Risks lxii% !mpactlxiii% !% idnappings terrorist threats etc.

lxiv% Iisrupted production higher security costsreduced productivity S

lxv% )% !ncreased taxation lxvi% Reduced after tax profits

lxvii% +% 5fficials* dishonesty lxviii% /oss of business increased operating costs

lxix%

lxx)

l,,i5 Cuses of Politicl Risk

lxxii% (ome of the important causes responsible for the political risk are$

lxxiii% "% C-n.e in Politicl Opinion$ 5ne of the most important causes of political

risk is the change in the political opinion of the host nation which generally

occurs with the change of government. #or example when Knron signed the

Iabhol power pro@ect in !ndia the &ongress government was in power at the

7/21/2019 4th unit


national level and in the state of 7aharashtra where the pro@ect was to be located.

7r. (harad Pawar the &ongress leader from 7aharashtra was a supporter of the

pro@ect. 9ut the problems started for Knron*s Iabhol pro@ect after the assemblyelections of "==- in which &ongress party was thrown out of power and it was

replaced by the 9P1(hiv (ena alliance. 6fter assuming power the alliance

government of 9P1(hiv (ena thought that there is something fishy in the Iabhol

power pro@ect and therefore set1up a committee under the chairmanship of

Nopinath 7unde deputy &hief 7inister to review the whole pro@ect.

)% Socil Unrest$ !t is another important cause which increase the political risk for anorgani3ation involved in international business. !t has been observed that social unrest

develops mainly because of the economic deprivation human rights violation violent

suppression of some groups and political intolerance. This unrest sometimes result in

change of government or it leads to demonstrations protests work stoppage etc. #or

example one of the worst sufferers of 6sian financial crisis of "==G was !ndonesia

where at one point of time the inflation rate rose to M< per cent and the economycontracted by ", per cent. This flared the social unrest in the nation that led to

demonstrations against companies owned by ethnic &hinese or foreign companies

employing ethnic &hinese. This resulted in serious property damage of the foreign

companies.

+% E,ternl Reltions$ !t refers to the relations between the host nation and the home

nation of the organi3ation involved in internal business orUt refers to the relationswhich the host nation has with other nations. !f the relations between the two

nations get stressed then the organi3ations of the two nations having interests in the

other nation suffer. #or example when #idel &astro came to power in &uba in

"=-= he talked about inciting revolutions in other parts of /atin 6merica. The

4.(.6. countered by cancelling its agreements to buy sugar from &uba and &uba in

turn sei3ed the assets of 4.(. oil refineries in its land.lxxiv%

7/21/2019 4th unit


l,,25 "ctors 3eter)inin. t-e Politicl Risk for Co)pnylxxvi%

lxxvii% #actors determining the political risk can be classified into two

categories$"% &ountry Related #actors and

)% &ompany Related #actors.

l,,2iii5 Country Relte$ "ctors

lxxix% The factors in these categories have been indicated below$

"% Econo)ic "ctors$ The factors in these categories have been indicated below$

i% "iscl 3iscipline$ 5ne of the important indicators of fiscal discipline is the fiscal

deficit as a percentage of gross national product. The higher is this ratio the

more the government is promising to its population relative to the resources it is

obtaining from them. The fiscal gap can force governments to resort to the

expropriation or create a politically risky situation.

ii% Controlle$ E,c-n.e Rte Syste): The controlled exchange rate system

compounds the balance of payment problem and thereby makes fiscal discipline

difficult. The control* should not be confused with regulations*. 9y controlled

system we mean the government using currency controls to fix exchange rate

i.e. the pegging of the currency. !n controlled exchange rate systems usually the

domestic currency is overvalued which implied subsidi3ing the imports.

iii% 6steful Go2ern)ent E,pen$iture$ Wasteful public spending is potential indicator

of financial problems. This spending refers to the unproductive spending in the

economy. !n this case even the borrowings from abroad are used to subsidi3e

consumption in the economy. !n this case the government has fewer saving to

draw on to pay foreign debt and therefore resorts to exchange controls and

higher taxes. This would in@ect inflation and capital flight into the economy.

iv% Resource /se$ When the natural resource base of an economy is strong the

country is less likely to be engulfed into economic instability. The nations are

7/21/2019 4th unit


different in their natural technological and financial resourcesA therefore political

risk assessment also re0uires analysis of the resource base. This is because

shortage or abundance of resources can cause economic political or socialinstability. #or example excess of population relative to other resources would

cause unemployment leading to social and political tensions.

v% Country7s Cpcity to A$8ust to E,ternl S-ocks$ !f a country has vast resource base

the country will process greater capacity to respond to external shocks. The

national spirit of population is also important factor to ad@ust to external shocks.

&uba and !ra0 are two countries where the national identity was responsible for bearing external shocks.

lxxx% 6nother important characteristic of a nation that makes it resilient

against external shocks is the sustained growth model being adopted for growth

in the economy. !f the development are internali3ed i.e. it does not depend on

foreign aid or foreign flow of funds then the economy becomes insulated to

external shocks.

)% Geo.rp-icl "ctors$ The nations are living !n a particular geographical

configuration arid that if the environment around the nation is hostile greater level

of political risk exists. 7ore number of border disputes implies greater degree of

political risk. (imilarly if a nation is more prone to calamities 'historical data%

greater is the political risk.

+% Sociolo.icl "ctors$ !n sociological factors we include religious diversity lingual

diversity ethnic diversity and political dogmatism. Nreater is religious diversity

the greater will be chances of social discontent because every religious group tries

to assert its supremacy over others. (imilarly the diversity in language and ethnic

groups create social tensions. !ndia is an example of religious language and ethnic

diversity. 7ost of the social tensions in the country are due to these diversities.

6fghan problem is also due to ethnic and tribal diversity. Political dogmatism

among various political groups also creates political instability in the country

7/21/2019 4th unit


resulting in higher political risk.

l,,,i5 Co)pny Relte$ "ctorslxxxii%

lxxxiii%The factors in these categories have been indicated below$

"% Nture of In$ustry$ The nature of the industry also determines the political risk. !t

is observed in the world that some industries are sub@ect to more government

regulations as compared to others. This is because these industries are seen as being

important to development and therefore the government wishes to control it. The

pricing of the product of these industries affect population in general therefore it is

necessary to control these for political hold on population. (ome industries are

crucial and strategic to some countriesA therefore these industries attract more

regulation.

)% Le2el of Opertion$ The companies with complex globally integrated operations

appear to be relatively safe from government intervention. These operations are

difficult to take over and regulate. #or example the parent company controls the

source of supply of a technology or raw materialA it is not possible for the

government to regulate this operation.

+% Le2el of Tec-nolo.y n$ Reserc- n$ 3e2elop)ent$ ;igh and sophisticated

technology companies and those companies having high degree of research and

development content are difficult to be regulated. This is because these 0ualities are

0uite individual and have been developed over a long period of time after sub stand

efforts.

,% Le2el of Co)petition$ The companies having little competition are also not

regulated because the host government is unable to replace them.

-% #orm of 5wnership$ The &ompany*s ownership is also an important component of

its vulnerability to risk. /ocal ownership is usually viewed favorably by

governments thus wholly owned subsidiaries are at greater risk while @oint

ventures with the locals are less risky.

% Ntionlity of Mn.e)ent$ !f the management is entirely foreign the company is

l bl t liti l i k th h i i d ti l i th

7/21/2019 4th unit


management or locals in the management.

lxxxiv% The fact that the degree of risk in any situation is a function of the

country and company specific risks the company while assessing the risk needs totake into account both types of risks.

l,,,25 Assess)ent of Politicl Risk lxxxvi%

lxxxvii% There are numerous approaches to the assessment of political

risk including event1tree analysis actuarial techni0ues or statistical decision theory.

#or the most part a mixture of sub@ective and ob@ective approaches dominates

corporate attempts to analy3e and assess a country*s political climate.

lxxxviii% 4sing tool and techni0ues once the sole province of economists and

corporate planners decision maker*s ire discovering a variety of ways to assess

political risk which are as follows$

"% Su48ecti2e Approc-es$ 7ost of the sub@ective approaches rely on human

@udgment and experience gained by specialists businessman diplomats or experts.

The classical sub@ective approaches to the assessment of political risk includes

three methodsA the Nrand Tours the old ;ands and the Ielphi techni0ues.

lxxxix%Grn$ Tours Met-o$$ The Nrand tours method is a particularly old techni0ue

generally based on the general impressions and information gained by the

multinationals. These impressions and informations are gathered through some

preliminary market research or an inspection tour of the company representatives. The

first impressions and information can also be gained through contact with local

leaders government officials and businessmen or through survey of the political

landscape for several days by company representatives. 6ll the information and

impressions gathered through this short survey of the political landscape are then

analy3ed and evaluated. (hortcomings of the Nrand tour approaches reside in its vague

nature and what Rummel and ;eenan called an overdose of selective information.

xc% Ol$ 9n$s Met-o$$ Through the old hands methods multinationals seek to

i t ti f di l t @ li t b i fi

7/21/2019 4th unit


experts on a consulting basis. The expertise of diplomats @ournalists or business

usually includes assessment of the ob@ectives and personalities of a country*s current

leadership the strengths and weaknesses of competing political groups and thelikelihood of new legislation,<. 5ne of the drawbacks of this approach is its

unsystematic character and the fact that it is based on the @udgments of outsiders.

;owever like Rummel and ;eenan points out the old hands methods can nevertheless

provide multinational corporations with an improved understanding of the political

dimension.

xci% 3elp-i Tec-ni#ues: The Ielphi techni0ues offer an example of a moreelaborate and systematic use of human @udgment and experience. !n the first part of the

Ielphi techni0ue corporate decision makers try to identify selective elements which

could influence a nation*s political destiny$ si3e and composition of the armed forcesA

delays experienced by the foreign investorsA political kidnappings etc. Dext a wide

range of experts is asked to rank or weigh the importance of these factors for the

country under consideration. Then responses are collected and a checklist of the

ranked variables is constructed. #inally the corporate decision makers aggregate the

ranked variables of the checklist into an overall measure or index of political risk.

)% O48ecti2e Approc-es$ 5ne way to overcome the above mentioned shortcomings

of the sub@ective approaches consists of making intensive use of 0uantitative data

on political factors and of the econometric and probabilistic methods to improve the

accuracy the precision and the predictability of political events.xcii% Multi2rite Anlysis M*A5: 5ne important ob@ective econometric techni0ue

employed for the ob@ective measurement of political risk is for instance 7ultivariate

6nalysis '786% which made multidimensional decisions possible. The 786 could

provide a very precious source of information for analy3ing complex issues such as

political risks. !ndeed refined 0uantitative tools for analy3ing political risk are gaining

favor among decision1makers of multinationals as another way to 2deal with politicalrisk or of confirming the OintuitiveO impressions gained in sub@ective analysis. The

7/21/2019 4th unit


786 can be classified on the basis of two possible uses$

a% to predict future political trends on the basis of current and historical

information or b% To describe more fully underlying relationships affecting the nation state.

xciii% The distinguishing feature of predictive techni0ues is that one or several

variables are said to be a function of some other variables.

xciv% Multiple Re.ression: !t is in fact one of the predictive techni0ues used by

decision1makers when the data are 0uantitative or numerical. ;owever prediction can

also involve 0ualitative or state1of1 being information for example. #or thosemanagers not concerned with prediction descriptive multivariate tool may provide

added meaning to a data base through for instance cluster analysis or

multidimensional sealing.

xcv% Met-o$olo.icl n$ Proce$url Solutions: Dow most corporate approaches

to political risk assessment stress methodological and procedural solutions to the

problem of political risk because of its precision and accuracy. Vet as suggested by

(trauch all ob@ective methods work on and within the context of a well defined model.

The model is treated as the problem and the problem is identifiable to the model.

Results drawn from the model are interpreted as conclusions on the problems itself

assuming that the problem structure matches or comes very close to that of the model.

Thus political risk is seen as an ob@ective attribute of the problem to be uncovered

measured and 0uantified through its counterpart in the model.

,c2i5 Mn.e)ent of Politicl Risk xcvii%

xcviii% #ollowing are the methods of management of political risk$

"% A2oi$in. In2est)ent: The simplest way to manage political risks is to avoid

investing in a country ranked high on such risks. Where investment has

already been made plants may be wound up or transferred to some other

country which is considered to be relatively safe. This may be a poor choice

as the opportunity to do business in a country will be lost.

7/21/2019 4th unit


)% A$pttion: 6nother way of managing political risk is adaptation.

6daptation means incorporating risk into business strategies. 7D&s

incorporate risk by means of the following three strategies$ local e0uity anddebt development assistance and insurance.

i% Locl E#uity n$ 3e4t$ This involves financing subsidiaries with the help of

local firms trade unions financial institutions and government. 6s partners

in local businesses these groups ensure that political developments do not

disturb operations. /ocali3ation entails modifying operations product mix or

any such activity to suit local tastes and culture. When 7cIonald2scommenced franchisee operations in !ndia it ensured that sandwiches did not

contain any beef.

ii%3e2elop)entl Assistnce: 5ffering development assistance allows an

international business to assist the host country in improving its 0uality of

life. (ince the firm and the nation become partners both stand to gain. !n

7yanmar for example the 4( oil company 4nocal and #rance2s Total have

invested billions of dollars to develop natural gas fields and also spent ?

million on local education medical care and other improvements.

iii%Insurnce: This is the last means of adaptation. &ompanies buy

insurance against the potential effects of political risk. (ome policies

protect companies when host governments restrict the convertibility of

their currency into parent country currency. 5thers insure against losses

created by violent events including war and terrorism.

+% T-ret: Political risk can also be managed by trying to prove to the

host country that it cannot do without the activities of the firm. This

may be done by trying to control raw materials technology and

distribution channels in the host country. The firm may threaten the

host country that the supply of materials products or technology would

be stopped if its functioning is disrupted.

7/21/2019 4th unit


,% Lo44yin.: !nfluencing local politics through lobbying is another way

of managing political risks. /obbying is the policy of hiring people to

represent a firm2s business interests as also its views on local politicalmatters. /obbyists meet with local public officials and try to influence

their position on issues relevant to the firm. Their ultimate goal is

getting favorable legislation passed and unfavorable ones re@ected.

-% Terroris) Consultnts: To manage terrorism risk 7D&s hire

consultants in counterterrorism to train employees to cope with the

threat of terrorism.

,ci,5 "inncil Risk c%

ci% #inancial risk in a company is associated with the method

through which it plans its financial structure. !f the capital structure of a

company tends to make earnings unstable the company may fail financially.

;ow a company raises funds to finance its needs and growth will have an

impact on its future earnings and conse0uently on the stability of earnings.

Iebt financing provides a low cost source of funds to a company at the same

time providing financial leverage for the common stock holders. 6s long as the

earnings of the company are higher than the cost of borrowed funds the

earnings per share of common stock are increased. 4nfortunately large

amounts of debt financing also increases the variability of the returns of the

common stock holders and thus increases their risk. !t is found that variation

in returns for shareholders in levered firms 'borrowed funds company% is

higher than in unlevered firms. The variance in returns is the financial risk.

cii% #inancial risk and business risk are somewhat related. While business

risk is concerned with an analysis of the income statement between revenues

and Karnings 9efore !nterest and Taxes 'K9!T% financial risk can be stated as

being between K9!T and Karnings 9efore Taxes 'K9T%. !f the revenue cost

7/21/2019 4th unit


and K9!T of a firm is variable it implies that there is business risk and in this

situation borrowed funds can magnify risk especially in unprofitable years.

Iebt in modest amounts is desirable. Kxcessive debt is to be avoided as thelong range profitability of the company can be depressed. The company should

constantly test its debt to fixed assets debts to net worth and debts to working

capital and give coverage of interest charges and preferred dividends by net

income after taxes. These methods will check imbalance in the firm*s financing

method and help to reduce risk.

ciii5 Types of "inncil Risk civ%

cv%#inancial risk can be divided into$

"% S-re-ol$er Risks: The complex relationship between the

shareholder*s base currency and the currencies of funds flows

underpins the profitability of an 7D& and will of course be affected

by movements in foreign exchange rates. #or example an 7D& that

generates a large proportion of its profits from 4( dollar sales will

present more of a financial risk for a Kuropean1based investor than for

a similar investor in

!

cvi%

the 4(6. !ndeed overseas interest in domestic stocks has been shown to be

significantly affected by long1term movements in exchange rates. #urthermore

the currency mix of an 7D&*s flows of funds is sometimes a crucial factor for

an investor who may select a particular stock precisely because of its natural

t

cvii% exposure to a certain basket of currencies. To the investor the holding

may form a hedge with other stocks held in a portfolio. '5f course

sophisticated shareholders will make greater efforts to fathom the particular

7/21/2019 4th unit


company*s hedging practises 1 a step lost on most investors.%

)% Opertin. n$ In2est)ent Risks$ (trategic decisions within the 7D& are

affected by movements in rates. ust as the external view of the long1termfinancial strength of the 7D& is influenced by rate fluctuations so too are

the internal evaluations of contributions from composite regions and

businesses. !ndeed the sensitivity to the effects of exchange rates can make

or break the case for investments in individual businesses and also for

potential ac0uisitions and divestment*s. #or 7D&s with global investments

the decision where to locate a new plant therefore re0uires close assessmentof currency trends.

+% Co)petitor Risks: #luctuating exchange rates can open up risks of loss and

opportunities for gain arising from the exposure to changes in relative

profitability between competitors. 7D&s competing in the same market can

have cost bases in different currencies. apanese and Nerman machinery

manufacturers exporting to the 4.(.6. in dollars not only have transaction

exposures to the dollar against their respective currencies but also

competitive exposures between the yen and the I1mark. The management of

these risks is often in the hands of the commercial department which

determines the currency of billing and pricing and negotiates currency1

variation clauses in contracts. Work force managers art becoming more aware

of competitiveness not only within the domestic market but also with directinternational competitors and alternative producers within the 7D&.

Kxchange1rate movements are an increasing financial risk.

cviii% Sources of "inncil Risk cix% #inancial risk arises through countless transactions of a financial nature

including sales and purchases investments and loans and various other

business activities. !t can arise as a result of legal transactions new pro@ects

mergers and ac0uisitions debt financing the energy component of costs or

7/21/2019 4th unit


through the activities of management stakeholders competitors foreign

governments or weather. When financial prices change dramatically it can

increase costs reduce revenues or otherwise adversely impact the profitabilityof an organi3ation. #inancial fluctuations may make it more difficult to plan and

budget price goods and services and allocate capital.

cx% There are three main sources of financial risk$

"% #inancial risks arising from an organi3ation*s exposure to changes in market

prices such as interest rates exchange rates and commodity prices.

)% #inancial risks arising from the actions of and transactions with other

organi3ations such as vendors customers and counterparties in derivatives

transactions.

+% #inancial risks resulting from internal actions or failures of the organi3ation

particularly people processes and systems.

cxi% Interest Rte Risk

cxii% !nterest rate risk is the chance that an unexpected change in interest

rates will negatively affect the value of an investment. 6 bank2s main source of

profit is converting the liabilities of deposits and borrowings into assets of loans

and securities. !t profits by paying a lower interest on its liabilities than it earns

on its assets>the difference in these rates is the net interest margin. 9anks

make money by borrowing at short1term rates and lending at long1term rates.

cxiii% #or

example a bank pays depositors " percent interest and lends their money to br

buyers through mortgages at - percent. The difference of , percent is the bank*s

profit. (hort1term $ .t rates

rise to

cxiv% percent and long1term interest rates rise to M percent. The bank is still

collecting - percent on its2loans but now must pay depositors percent losing

money at a rate of " percent

7/21/2019 4th unit


cxv% ;owever the terms of its liabilities are usually shorter than the terms of

its assets. !n other words the interest rate paid on deposits and short1term

borrowings are sensitive to short1term rates while the interest rate earned onlong1term liabilities is fixed. This creates interest rate risk which in the case of

banks is the risk that interest rates will rise causing the bank to pay more for

its liabilities and thus reducing its profits.

cxvi%

cxvii%

cxviii%

cxix%

cxx%

cxxi%

cxxii%

cxxiii%

cxxiv% (ources of !nterest Rate Risk

cxxv% 6s financial intermediaries banks encounter interest rate risk in

several ways. 9roadly these can be described

cxxvi% "% Refinncin. Risk: Refinancing risk is the risk that a borrower is not able to

redeem an existing loan with the proceeds of a new loan 'and an extra e0uity

payment% at loan maturity. The recovery risk relates to the loan being unable to be

refinanced and the underlying properties need to be sold or foreclosed to provide

for funds for redemption. The extension risk is the risk that redemption of the loan

does not occur at maturity but later.

cxxvii% Refinancing risk is the uncertainty of the cost of a new source of funds

that are being used to finance a long1term fixed1rate asset. This risk occurs when an

#! is holding assets with maturities greater than the maturities of its liabilities.

iii% R fi i Ri k

7/21/2019 4th unit


cxxix%1111111111111111111! 111111111111111111111111111111111 !

" SF /iabilities 1 X1111111111111111111111111111111" Vear

) Yl1111111111111111111111111111111lcxxx% <11111111111111!"11111111111111111111111111111 6ssets " Vear X ) Vear

cxxxi% #or example if a bank has a ten1year fixed1rate loan funded by a )1year

time deposit the bank faces a risk of borrowing new deposits or refinancing at a

higher rate in two years. Thus interest rate increases would reduce net interest

income. The bank would benefit if the rates fall as the cost of renewing the deposits

would decrease while the earning rate on the assets would not change. !n this case

net interest income would increase.

)% Re1!nvestment Risk$ Re1investment or refunding risk arises when interest rates at

investment maturities 'or debt maturities% result in funds being re1invested 'or

refinanced% at current market rates that are worse than forecast or anticipated. The

inability to forecast the rollover rate with certainty has the potential to impact

overall profitability of the investment or pro@ect.

cxxxii% Reinvestment risk is the uncertainty of the earning rate on the

redeployment of assets that

cxxxiii% have matured. This risk occurs when an #! holds assets with maturities

that are less than the maturities of its liabilities.

cxxxiv%11111111111111111111111111111111111111111111111111111! "

cxxxv%1111111111111<111111111111111111111111111111111F 6ssets X " Vear

cxxxvi% #or example a short1term money market investor is exposed to

the possibility of lower interest rates when current holdings mature. !nvestors who

purchase callable bonds are also exposed to re1investment risk. !f callable bonds are

called by the issuer because interest rates have fallen the investor will have

proceeds to re1invest at subse0uently lower rates.

l ;

< ) Vear

Rein2est)ent Risk

<<<<<<<<< /iabilities <

/iabilities

7/21/2019 4th unit


cxxxvii% (imilarly a borrower that issues commercial paper to finance longer1

term pro@ects is exposed to the potential for higher rates at the rollover or

refinancing date. 6s a result matching funding duration to that of the underlying pro@ect reduces exposure to refunding risk.

cxxxviii% Re1investment risk is defined as “the variability in the returns

from re1investment from a given strategy due to changes in market rates2F.

cxxxix% Re1investment risk a challenge all investors face when bond yields are

falling is the risk that future cashflows 1 either coupons or the final return of

principal > will need to be re1invested in lower1yielding securities.

+% Re1Pricing Risk$ This risk arises from holding assets and liabilities with different

principal amounts maturity or re1pricing dates thereby creating exposure to

unexpected changes in the interest rates. #or example$

cxl) /sis Risk: Kven where asset and liabilities are properly matched in terms of

re1pricing risk one is exposed to the risk that correlation between change in interest

rate on assets may not be the same as change of interest rate on liabilities thereby

affecting the underlying spread at the time of re1pricing. Therefore the risk that

interest rate of different assets and liabilities may change in different magnitude is

called basis risk. To illustrate the point let us take the following example

ii% /iability iii% 6sset iv% Result

v% + 7onthsdeposit

vi% - Vears bond vii% /iability sensitive as after every threemonths deposits will have to be rolled over and

every rollover will be sub@ect to interest rates prevailing at the time of roll1over.

viii% + Vearsdeposit

ix% + Vears bond with months reset i.e. floating rate bond where interest will be fixed

x% 6sset sensitive. &ost of liabilities isconstant for + years while earnings on asset aresub@ect to vagaries of interest rate movement.

xi% ) Vearsdeposit

xii% +, Iays treasury bill xiii% 6sset sensitive. Treasury bills when rolleover after +, days may give a different yield aroll1over will be sub@ect to rates prevailing at tha

xiv% - Vears

deposit

xv% - Vears term loan xvi% Deutral as both assets and liabilities are

properly matched.xvii)

7/21/2019 4th unit


cxli)

cxlii% When interest rates change these differences can give rise to

unexpected changes in the cashflows and earnings spread between assets

liabilities and off balance sheet instruments of similar maturities or repricing

fre0uencies.

,%E)4e$$e$ Option Risk: /arge changes in the level of interest encourage

premature withdrawal of deposits on the liability side or pre1payment of

loans on the asset side. 9onds with put and call option may also be redeemed

before their original maturity as holder will like to exercise put option if

interest rates in the meantime have edged up while the issuer will exercise

call option if interest rates have fallen.

cxliii% Kvery time a deposit is withdrawn or a loan is prepaid it creates a

mismatch and gives rise to re1pricing risk. (ince customers on both sides of the

balance sheet of the bank en@oy this embedded option their abrupt

decisionJbehavior based on interest rate movement may give rise to re1pricing

risk where it did not exist in the first instance. !n order to protect themselves

from this risk banks impose penalties on premature withdrawal of deposits.

-% =iel$ Cur2e Risk: Vield curve risk is the risk of experiencing an adverse shift in

market interest rates associated with investing in a fixed income instruments.

The risk is associated with either a flattening or steepening of the yield curve

which is a result of changing yields among comparable bonds with different

maturities.

cxliv% When market yields change this will impact the price of fixed1income

xviii%

xix% Re1Pricing xx% Re1Pricing 6ssetsxxi% Resultxxii% =< Iays

certificate of deposits

xxiii% =< Iays

commercial paper

xxiv% 6t re1pricing certificate of

deposit rates may fall by @ust <.-: p.a.

while interest rates on &.P. may fall by

xxv)

7/21/2019 4th unit


instruments. When market interest rates or yields increase the price of a bond

will decrease and vice versa

cxlv%

cxlvi% Mn.e)ent of Interest Rte Risk cxlvii% !nterest rate risk management is not purely about managing the

interest line in the profit and loss account. !t also encapsulates the management

of the whole debt profile of the business including the maturity of the debt the

currency of the debt and the fixed floating mixture of the debt and expectation

of future interest rates.

cxlviii%7anaging interest rate risk is a fundamental component in the safe

and sound management of all institutions. !t involves prudently managing

mismatch positions in order to control within set parameters the impact of

changes in interest rates on the institution. (ignificant factors in managing the

risk include the fre0uency volatility and direction of rate changes the slope of

the interest rate yield curve the si3e of the interest1sensitive position and the

basis for re1pricing at rollover dates.

cxlix% 6lthough the particulars of interest rate risk management will differ

among institutions depending upon the nature and complexity of their asset and

liability structure 'both on and off1balance sheet% interest rate risk positions and

risk profile a comprehensive interest rate risk management programme re0uires$

"% Kstablishing and implementing sound and prudent interest rate risk policies

)% Ieveloping and implementing appropriate interest rate risk measurement techni0ues.

+% Ieveloping and implementing effective interest rate risk management and control

procedures.

cl5 Risk Mn.e)ent t-rou.- 9e$.in.

cli% !n the event that a company chooses to manageJeliminate

transaction exposure there are a variety of hedging techni0ues available if the

transaction will take place in less than one year. &ompanies would do well to

7/21/2019 4th unit


price or evaluate the costs of several techni0ues in order to make an optimal

choice.

clii)

cliii5 Nturl 9e$.es

cliv%

clv% !nternal techni0ues of exposure management comprise those that

are part of a firm*s regulatory financial management and do not resort to

special contractual relationship outside the group of companies concerned.

The primary ob@ective of this group of hedging techni0ues is to reduce

exposed positions or prevent them from occurrence.

clvi% !nternal techni0ues embrace the following$

clvii% !% Risk>S-rin.: !t is a contractual arrangement through which the

buyer and the seller agree to share the exposure. 9oth the parties normally

agree to such a proposal if their business relationship is a long1term one.

4nder this arrangement a base rate is fixed with mutual consent that is

generally the current spot rate. 6 neutral 3one is also agreed upon which is a

few points minus and plus the base rate. When the exchange rate changes

within the neutral 3one the transaction takes place at the base rate but if the

exchange rate crosses the neutral 3one the risk is shared e0ually by the two

parties. (uppose the base rate is E,<J4.(. dollar and the neutral 3one is C".<J1

".< per cent. !f the rupee depreciates to ,) a 4.(. dollar and if the value of the

transaction is 4.(. ?"<<< the si3e of exposure will be E',).< 1 ,<.<% Z "<<< B

E)<<< 5ne1half of the exposed amount that is E "<<< will be borne by one

xxvi)

7/21/2019 4th unit


party and the other half will be borne by the other party. !n other words the

!ndian party is able to hedge E)<<<1exposure by -<.< per cent through the use

of this techni0ue.)% Prllel Lons: 6 parallel loan is often known as a back1to1back loan or credit

swap loan. 4nder this arrangement the amount of the loan moves within the

country but it serves the purpose of a cross1border loan. 6t the same time such

loans are not exposed to the changes in exchange rate because the funds do not

move across the national border. (uppose a 4.(. parent company has a subsidiary

in !ndia. 6t the same time an !ndian parent company has a subsidiary in the 4.(.6.(uppose further that the 4.(. parent company has to lend 4.(. ?"<<< to its

subsidiary in !ndia for a specific period. The !ndian parent company too has to lend

to its subsidiary in the 4.(.6. a similar amount for the same maturity. !f the funds

move between the two counties and if the exchange rate changes transaction

exposure will result. To avoid this exposure the !ndian parent company will lend

the above amount converted into rupees at the spot exchange rate to the 4.(.

subsidiary. (imultaneously the 4.(. parent company will lend similar amount in

terms of 4.(. dollars to the !ndian subsidiary. 6t the expiry of the specified period

the two loans will be repaid to the respective lenders. #igure ,.) shows how the

transactions take place under the back1to1back loan arrangement.

clviii)

xxvii)

xxviii% "i.ure : Cretion of Prllel!/ck>to>/ck Lon

7/21/2019 4th unit


cli,5 This is no doubt an efficacious techni0ue of hedging the transaction

exposure but it is difficult to find a firm that has to lend a similar amount for a

similar maturity. !f such a firm known as counter1party is located it cannot beguaranteed that the counter1party would repay the loan within the specified period.

!f it fails to make repayments counter1party risk would emerge. !t is this particular

limitation with the parallel loan that has made the currency swap popular.

+% Mtc-in. of Cs-flo?s: 4nder this mechanism a firm matches its foreign

currency inflow with the outflow in that currency not only in respect of si3e

but also in respect of timing. 9ut for this purpose the firm must have bothinflows and outflows in the same currency.

,% Pricin. of Trnsctions: !n exposure management the pricing policy

adopted is of two kinds namely price variation and the currency of

invoicing. Price variation involves marking up or marking down of the sale

price to counter the adverse effects of exchange rate changes. The normal

rule is to charge the price in foreign currency on the basis of forward rate and

not the spot rate. !n case of se0uential payments to be made or received at

different times a weighted average of forward rates of different dates is

computed. &harging of a different price from the arm*s1length price is a

..usual practice in case of intra1firm transactions. 9ut for the purpose of

exposure management this practice is adopted also in inter1firm transactions.

+% In2oicin.!/illin. In 3esire$ Currency$ !nvoicing sales as well as purchases

in the home currency is an ideal method of hedging foreign exchange risk.

9illing in home currency enables the firm to know the precise amount it is

likely to receive from sales 'exports% and likewise the exact amount it is to

pay for purchases '!mports%. 6s a result its foreign exchange risk is

completely eliminated. !n other words currency of invoicing is a hedging

techni0ue in which a firm may be able to shift the entire risk to another party by invoicing its exports in its home currency and insisting that its imports too

7/21/2019 4th unit


be invoiced in its home currency but in the presence of well functioning

forwards markets this will not yield any added benefit compared to a forward

hedge. 6t times it may diminish the firm*s competitive advantage if itrefuses to invoice its cross1border sales in the buyer*s currency.

clx%!n invoicing of transactions the exporter may be willing to invoice the bill

in its own currency or in the currency in which it incurs the1cost so that the

transaction exposure is avoided but if the importer is dominant the bill is

normally invoiced in the importer*s currency. !n other cases the exporter

follows theclxi) 7arket leader or its ma@or competitors

although it avoids currencies in which

clxii) The forward market is limited or the

convertibility of which is limited. !t also avoids

clxiii) ;ighly volatile currency.

clxiv% !n countries where exchange control measures limit taking of

positions in foreign currencies the exports and imports are invoiced in

home currency irrespective of its strength and weakness. This is a defensive

strategy. ;owever an aggressive policy is also adopted so that exports are

invoiced in hard currency and imports are invoiced in weak currency.

clxv% !t may be noted here that this techni0ue does not figure

significantly in intra1firm transactions as the gain accruing to one unit is

offset by the loss incurred by the other unit of the firm. Devertheless the

advantages appearing on account of tax differential between two countries

encourage intra1firm transactions to be invoiced in either appreciating or

depreciating currency. #or example there are two subsidiaries of a firm

located in country 6 and country 9. The marginal tax in country 6 is higher

than in country 9. !n such a case other factors remaining the same the

7/21/2019 4th unit


subsidiary in country 6 shall invoice the transaction with 9 in the weak

currency and the subsidiary in country 9 shall invoice the transaction in the

strong currency. This way before1tax profit of the subsidiary in country 6can be passed on to that in country 9 if the currency depreciates further and

so ultimately the tax burden of both the subsidiaries will be lower.

clxvi% 6nother way of using the choice of invoicing currency as a

hedging tool relates to the outlook of a firm about various currencies. This

involves invoicing exports in a hard currency and imports in a soft currency.

The currency so chosen may not be the domestic currency for either of the parties involved and may be selected because of its stability 'like the dollar

which serves as an international currency%. 6nother hedging tool in this

context is the use of “currency cocktails” for invoicing. #or example

9ritish importer of fertili3er from Nermany can negotiate with the supplier

that the invoice is partly in IK7 and partly in (terling. This way both the

parties share exposure. 6nother possibility is to use one of the “standardcurrency baskets” such as the (IR or the K&4 for invoicing trade

transactions.

clxvii% 9asket invoicing offers the advantage of diversification and can

reduce the variance of home currency value of the payable or receivable as

long as there is no perfect correlation between the constituent currencies.

The risk is reduced but not eliminated. 6lso there is no way by which the

exposure can be hedged since there is no forward market in these composite

currencies. 6s a result this techni0ue has not become very popular.

clxviii% !n the following cases invoicing is used as a means of hedging$

i% Trade between developed countries in manufactured products is

generally invoiced in the exporter*s currency.

ii% Trade in primary products and capital assets are generally invoiced in a

@ hi l h th 4 ( d ll

7/21/2019 4th unit


iii% Trade between a developed and a less developed country tends to be

invoiced in the developed country*s currency.

iv% !f a country has a higher and more volatile inflation rate than its trading

partners there is a tendency not to use that country*s currency in trade

invoicing.

clxix% 9e$.in. ?it- Currency 3eri2ti2es

clxx% The various methods available to a firm to hedge its transaction

exposure

clxxi% are discussed below$

clxxii)

clxxiii% "or?r$ Mrket 9e$.eclxxiv% !n a forward market hedge a company that is long in a foreign

currency will sell the foreign currency forward whereas a company that

is short in a foreign currency will buy the currency forward. !n this way the

company can fix the dollar value of future foreign currency cash flow.

clxxv% !f funds to fulfill the forward contract are available on hand or are

due to be received by the business the hedge is considered OcoveredO

Operfect or Os0uareO because no residual foreign exchange risk exists. #unds

on hand or to be received are matched by funds to be paid.

clxxvi% !n situations where funds to fulfill the contract are not available but

have to be purchased in the spot market at some future date such a hedge isconsidered to be OopenO or OuncoveredO. !t involves considerable risk as the

xxix)

7/21/2019 4th unit


hedger purchases foreign exchange at an uncertain future spot rate in order to

fulfill the forward contract.

clxxvii% Options Mrket 9e$.e

clxxviii% !n many circumstances the firm is uncertain whether the

hedged foreign currency cash inflow or outflow will materiali3e. &urrency

options obviate this problem. There are two kinds of options$

"% 6 put option gives the buyer the right but not the obligation to sell a specified

number of foreign currency units to the option seller at a fixed price up to the

option2s expiration date.

clxxix% 6lternatively a call option is the right but not the obligation to buy a

foreign currency at a specified price upto the expiration date.

)% 6 call option is valuable for example when a firm has offered to buy a foreign

asset such as another firm at a fixed foreign currency price but is uncertain

whether its bid will be accepted.

clxxx% 6s an illustration consider an 6merican importer that must pay a

apanese company )-<<<< yen on the third Wednesday of Iecember.

7anagement wants to protect the buyer from large losses that would be incurred

if the value of the yen increases before the obligation is paid.

clxxxi% The current value of the yen is ?<.<<G) so the importer buys a

Iecember call option for )-<<<< yen at an exercise price of ?<.<<G) per yen.

!n addition to the broker2s commission of ?)-.<< the importer must pay a

premium of ?<.<<<"- per yen or ?=+G.-< [ B '<.<<"-% ')-<<<<%\.

clxxxii% !f by the third Wednesday in Iecember the value of the yen falls to

?<.<<M then the 6merican business discards the option and buys the )-<<<<

yen at the new spot rate for ?,)-<<$

clxxxiii% The total cost to the company would be ?,+,).-<$

clxxxiv% !f the value of the yen rises above ?<.<<G) the company exercises

7/21/2019 4th unit


the call option and buys the )-<<<< yen at the exercise price of ?<.<<G) per

yen and pays ?,-<<< to satisfy the account payable$

clxxxv% The total cost to the company never exceeds ?,-=).-< but the cost

may be much less depending on how low the value of the yen falls.

clxxxvi% !n the event the importer has a receivable account denominated in yen

it can purchase a yen put option. The put option gives the importer the right to sell

the yen that it receives to the writer of the option at the exercise price specified in

the option contract. ;ence the company is guaranteed a minimum total dollar

amount in the future that is e0ual to the exercise value of the option less the

premium and commission paid for the put option. !f the value of the yen rises the

firm discards the put option and receives the new dollar value of the yen receivable

less the amount of premium and commission paid on the option.

clxxxvii% While option hedges appear to place the company in a no1lose situation

the actual benefits of option hedges are more in doubt. Regardless of whether the

option is exercised the company always bears the full cost of the option premium

and commission. !n effect the company substitutes an unknown and potentially

disastrous loss with a smaller but certain cost.

clxxxviii% !n this sense an option hedge is very similar to the purchase of

insurance. '!n fact option models can be used to estimate insurance premiums.% The

total benefit of an option hedge involves a trade1off between avoiding risk of

potential losses and the certain monetary cost of the option. !f the option market is

efficient the net monetary benefit of an option hedge to the company is negligible

or even slightly negative due to transaction costs. The gain to the company is the

reduction in uncertainty.

7/21/2019 4th unit


,,i,5 Money Mrket 9e$.ecxc% 7oney market hedging involves simultaneous borrowing and lending or investing

in the money market with an aim to avoid or reduce foreign exchange exposure with

regard to receivables or payables. 6 firm that wants to hedge foreign exchange exposure on

receivables 'payables% may borrow 'lend% foreign currency in the money market so that its

assets and liabilities in the same currency will match. 5nly firms that have access to the

international money market can use this type of hedging effectively. 6ny restrictions on the

borrowing or lending in the foreign currency may limit the use of this techni0ue.

Devertheless money market hedging is particularly used for cashflows in currencies for

which there are no forward markets.

cxci% 7oney market hedging involves taking a money market position to hedge

exposure on foreign currency receivables or foreign currency payables. 6n exporter who

wants to hedge receivables in a foreign currency may borrow a certain amount in the

currency denominating the receivables get that foreign currency1 denominated amount

converted into home currency in the spot market and then invest it for a period coinciding

with the period of receivables. Then the exporter pays off the foreign currency loan with the

receivables amount.

cxcii% #or example suppose an 6merican business expects to receive four million

9ra3ilian cru3eiros in one month from a 9ra3ilian customer. There is no futures contract for

the cru3eiro. #urthermore banks fearful of foreign exchange controls 0uote very large

bidJask spreads on forward rates for the cru3eiro. The business could still eliminate

uncertainty about the rate of currency exchange by borrowing ++++ cru3eiros in 9ra3il

at an interest rate of "< percent per month 'inflation and interest rates are extremely high in

9ra3il%.

cxciii%The company can convert the cru3eiros into ?=<=<.=" at the spot rate of ?<.<<)- per

cxciv% cru3eiro as follows$

7/21/2019 4th unit


cxcv% When the four million cru3eiros receivable is paid by the 9ra3ilian customer one

month later it is used to pay off the principle and interest accrued on the loan in 9ra3il$

cxcvi% !f the 6merican company had an account payable in cru3eiros in 9ra3il it could

also use a money market hedge by '"% borrowing dollars in the 4.(. ')% converting theminto cru3eiros at the spot rate and then '+% investing the cru3eiros in 9ra3il until the

payable is due.

cxcvii% The cost of a money market hedge is the difference between the borrowing and the

lending interest rates. 7ost companies and individuals must pay more to borrow funds than

they can receive when they lend funds. 9anks must lend funds at a higher interest rate than

they pay for funds in order to earn a profit.

cxcviii% They demand an even higher interest rate if there is any risk of

default. !n order to reduce the risk banks often re0uire borrowers to pledge the receivable

as collateral on the loan. !f the receivable presents a low risk the bank will re0uire a lower

interest rate. !f the business is borrowing for a future payable it can pledge the cru3eiro

deposit as collateral.

cxcix% When the risk to the bank is low the company2s borrowing and lending rates

are close to the risk1free rate. !n this case a money market hedge may be the least costly

hedging techni0ue even if forward rates and futures contracts are available.

9e$.in. Recurrent E,posure T-rou.- S?pscci% 6 swap is a foreign currency contract whereby the buyer and seller exchange e0ual

initial principal amounts of two different currencies at the spot rate. The buyer and seller

exchange fixed or floating rate interest payments in their respective swapped currencies

over the term of the contract. 6t maturity the principal amount is effectively re1swapped at

a predetermined exchange rate so that the parties end1up with their original currencies. The

advantages of swaps are that firms with limited appetite for exchange rate risk may move to

a partially or completely hedged position through the mechanism of foreign currency

7/21/2019 4th unit


swaps while leaving the underlying borrowing intact. 6part from covering the exchange

rate risk swaps also allow firms to hedge the floating interest rate risk. #or example an

export oriented company that has entered into a swap for a notional principal of 4(I " mn

at an exchange rate of ,)Jdollar.

ccii% The company pays 4(I in months /!95R to the bank and receives "".<<:

every months on "“ anuary and "st uly till - years. (uch a company would have earning

Iollars and can use the same to pay interest for this kind of borrowing 'in dollars rather tha

rupee% thus hedging its exposures.

i% 9e$.in. Contin.ent E,posure

cciv% ]n addition to providing a flexible hedge against exchange exposure options contr

n also provide an effective hedge against what might be called contingent exposure. &onting

posure refers to a situation in which the firm may or may not be sub@ect to exchange exposure.

ccv% The principle focus is on the items which will have the impact on the cashflows of th

d whose values are not contractually fixed in foreign currency terms. &ontingent exposure has a

orter time hori3on. Typical situation giving rises to such exposures are$

"% 6n export and import deal is being negotiated and 0uantities and prices are yet not to

finali3ed. #luctuations in the exchange rate will probably influence both and then it will

converted into transactions exposure.

)% The firm has submitted a tender bid on an e0uipment supply contract. !f the contrac

awarded transactions exposure will arise.

+% 6 firm imports a product from abroad and sells it in the domestic market. (upplies from abr

are received continuously but for marketing reasons the firm publishes a home currency p

list which holds good for six months while home currency revenues may be more or l

certain costs measured in home currency are exposed to currency fluctuations.

ccvi% ^

ii% !n all the cases currency movements will affect future cashflows.

7/21/2019 4th unit


iii% 9e$.in. T-rou.- In2oice Currencyccix% !nvoicing sales as well as purchases in the home currency is an ideal method

hedging foreign exchange risk. 9illing in home currency enables the firm to know

precise amount it is likely to receive from sales 'exports% and likewise the exact amount it

pay for purchases '!mports%. 6s a result its foreign exchange risk is completely eliminated.

ccx% !n invoicing of transactions the exporter may be willing to invoice the bill in

own currency or in the currency in which it incurs the cost so that the transaction exposur

avoided but if the importer is dominant the bill is normally invoiced in the importer*s curren

!n other cases the exporter follows the market leader or its ma@or competitors althoug

avoids currencies in which the forward market is limited or the convertibility of which

limited. !t also avoids highly volatile currency.

ccxi% !n countries where exchange control measures limit taking of positions in f

currencies the exports and imports are invoiced in home currency irrespective of its streng

weakness. This is a defensive strategy. ;owever an aggressive policy is also adopted s

exports are invoiced in hard currency and imports are invoiced in weak currency.

ccxii% !t may be noted here that this techni0ue does not figure significantly in intr

transactions as the gain accruing to one unit is offset by the loss incurred by the other unit

firm. Devertheless the advantages appearing on account of tax differential between two cou

encourage intra1firm transactions to be invoiced in either appreciating or depreciating curren

ccxiii% #or example there are two subsidiaries of a firm located in country 6 and c

9. The marginal tax in country 6 is higher than in country 9. !n such a case other f

remaining the same the subsidiary in country 6 shall invoice the transaction with 9 in the

currency and the subsidiary in country 9 shall invoice the transaction in the strong currency

way before1tax profit of the subsidiary in country 6 can be passed on to that in country 9

currency depreciates further and so ultimately the tax burden of both the subsidiaries w

lower.

ccxiv% 6nother way of using the choice of invoicing currency as a hedging to

7/21/2019 4th unit


relates to the outlook of a firm about various currencies. This involves invoicing exports in

hard currency and imports in a soft currency. The currency so chosen may not be th

domestic currency for either of the parties involved and may be selected because of i

stability 'like the dollar which serves as an international currency%. 6nother hedging tool

this context is the use of “currency cocktails” for invoicing.

ccxv% #or example 9ritish importer of fertili3er from Nermany can negotiate wi

the supplier that the invoice is partly in IK7 and partly in (terling. This way both the parti

share exposure. 6nother possibility is to use one of the “standard currency baskets” such a

the (IR or the K&4 for invoicing trade transactions.

cxvi% 9asket invoicing offers the advantage of diversification and can reduce the varianf home currency value of the payable or receivable as long as there is no perfect correlatio

etween the constituent currencies. The risk is reduced but not eliminated. 6lso there is no wa

y which the exposure can be hedged since there is no forward market in these composi

urrencies. 6s a result this techni0ue has not become very popular.

cxvii% !n the following cases invoicing is used as a means of hedging$

% Trade between developed countries in manufactured products is generally invoiced inccxviii% the exporter*s currency.

)% Trade in primary products and capital assets are generally invoiced in a ma@or vehic

currency such as the 4.(. dollar.

+% Trade between a developed and a less developed country tends to be invoiced in th

developed country*s currency.

,% !f a country has a higher and more volatile inflation rate than its trading partners there istendency not to use that country*s currency in trade invoicing.

ccxix% 6lthough the method provides a natural hedge it may not be operationally feasible

e used always and by all firms. 5nly firms having high demand for their products across th

world and those having products with low price1elasticity e.g. petroleum productsJwith lo

ompetitionJwith less substitutes available may be in a strong position with their counterparty

7/21/2019 4th unit


make them agree to receiveJpay in their own home currency. This implies that the company shou

e in a very strong position to impose billing either in its own domestic currency or currency

ts choice on the other party. !n the current world of globali3ation the number of such firm

ecreasing. !n fact the vast ma@ority of companies have to encounter competition on many fron

nd hence it is likely to be a very daunting task for them to force the counterparty to have billin

n the currency of their choice. !n sum relatively few firms may en@oy hedge luxury* of this sort

,5%

xii% 9e$.in. T-rou.- Le$in. n$ L..in.cxxiii%

cxxiv% (ound international financi

management practices warrant that the firms engaged in international operations should endeav

o have their assets in a strong currency and liabilities in a weak currency. This may be achieve

with the help of the techni0ue known as leading and lagging* 'also called leads and lags% b

d@usting the timing of receipts and payments 'related to current account transactions%. /eading

ts name implies is taking the lead to collect from foreign currency designated debto

xpeditiously before they are due 'when the home currency is expected to strengthen% and

nitiate lead to pay foreign currency designated creditors before their due date of payment 'whe

epreciationJdevaluation of the home currency is apprehended%. Payment to creditors on maturi

n such a situation will obviously involve more cash outflow of home currency as the foreig

urrency is likely to become costlier. /ikewise when an upward movement of the home currenc

s expected early receipts from foreign currency designated debtors2will lead to higher hom

urrency receipts. Q i 8 "

cxxv% !n contrast lagging as the name implies is delaying receipts from the foreig

urrency designated receivables whose currencies are likely to appreciateJstrengthen and delayin

oreign currency designated payables whose currencies are likely to depreciateJdevalueJweake

This makes financial sense on account of more receipts from debtors and less payment

reditors.

7/21/2019 4th unit


xxvi% Therefore to receive maximum receipts or make minimum payment in appreciatio

one countries accounts receivables 2are collected as soon as possible and payment of accoun

ayable is delayed as long as possible. The converse will hold true in depreciation1prone countrie

btors are collected as late as possible and creditors are paid as early as possible.

xxvii%

cc,,2iii5 9e$.in. T-rou.- Nettin.ccxxix%

ccxxx% E,posure nettin. in2ol2es offsettin. e,posures in one currency ?it- e,posures

ccxxxi% in t-e s)e or not-er currency@ ?-ere e,c-n.e rtes re e,pecte$ to )o2e in

ccxxxii% suc- ?y t-t losses .ins5 on t-e first e,pose$ position s-oul$ 4e offset 4y

ccxxxiii% .ins losses5 on t-e secon$ currency e,posure&

ccxxxiv% T-e ssu)ption un$erlyin. e,posure nettin. is t-t t-e net .in or loss o

ccxxxv% entire e,posure portfolio is ?-t )tters@ rt-er t-n t-e .in or loss on

ccxxxvi% ny in$i2i$ul )onetiy unit& To -2e suc- nettin.@ it is i)portnt t-t t-e

ccxxxvii% $tes of settle)ent s-oul$ )tc- n$ t-e forei.n currency in2ol2e$ s-oul$

ccxxxviii% 4e t-e s)e for receipts n$ py)ents t-t re $ue&

ccxxxix% Since t-e risk e,posure is -e$.e$ for 4ot- prties@ t-ey try to )tc- t-e )

$tes n$ currencies of su)s recei24le n$ py4le 4et?een t-e)sel2es&

ccxl% Types of Nettin.

ccxli% "ollo?in. re t-e types of nettin.:

ccxlii% (5 /ilterl Nettin.: Nettin. in2ol2in. t?o prties is referre$ to s 4ilterl ne

/ilterl nettin. is fesi4le 4et?een ny t?o trnsctin. co)pnies&

7/21/2019 4th unit


ccxliii% "or e,)ple@ Co)pny e,ports .oo$s to Co)pny = for USB ' )illio

i)ports .oo$s ?ort- USB (&0 )illion fro) Co)pny =& T-eir $tes of )turity re t-e

"i.ure %&+ s-o?s t-e )o2e)ent of fun$s 4et?een t-ese t?o co)pnies& T-e )o2e)

fun$s ?it- nettin. is s-o?n in fi.ure %&+&

ccxliv% In absence of netting the total exposure of the two companies is 4(? +.- millioexposure is reduced substantially to the net sum of 4(? <.- million payable by V to _.

lv% )% 7ultilateral Detting$ Detting with more than two parties is called multilateral n

7ultilateral netting is practiced among multinational corporations having subsidiaries.

ccxlvi% 7ultilateral Detting can be explained with the help of the following table ,." and

,., and figure

ccxlvii% ,.-.

lviii% #or example a company has four subsidiaries and payment and receipts are

following manner$

ccxlix)

ccl)

ccli)

cclii)

ccliii)

ccliv)

cclv)

cclvi)

cclvii)

4(? ) million

#igure +.)$ Dormal 7ovement of #unds

#igure ,.+$ 7ovement of #unds with Detting

xxx%YYYYYYYYYYYYYYYYYYYYYYYYYYTable ,."xxxi)

xxxii% &ountryxxxiii% Receipt

sxxxiv% Payment

s xxxv% Det toJfrom &enter

xxxvi% 4.(. xxxvii% +<<<< xxxviii% "<<<<< xxxix% 1G<<<<

xl% &anadaxli% "=<<<

<xlii% 1

xliii% C "=<<<<

xliv% #rance xlv% )<<<< xlvi% G<<<< xlvii% 1-<<<<

xlviii% 4.. xlix% #0,000, l% M<<<< li% 1G<<<<

lii%

liii%

liv%lv% <

7/21/2019 4th unit


cclviii)

cclix)

cclx)

cclxi)

cclxii)

cclxiii)

cclxiv)

cclxv)

cclxvi)

cclxvii)

cclxviii)

cclxix)

cclxx)

cclxxi)

cclxxii)

cclxxiii)

cclxxiv)

cclxxv)

cclxxvi)

cclxxvii)

cclxxviii)

cclxxix)

cclxxx)

cclxxxi)

cclxxxii)

cclxxxiii)

cclxxxiv)

cclxxxv)

cclxxxvi)

cclxxxvii)

cclxxxviii)

cclxxxix)

7/21/2019 4th unit


ccxc)

ccxci)

ccxcii)

ccxciii)

ccxciv)

ccxcv)

ccxcvi)

ccxcvii)

ccxcviii)

ccxcix)

ccc)

ccci)

cccii)

ccciii)

ccciv)

cccv)

cccvi)

cccvii)

cccviii)

cccix)

cccx)

cccxi)

cccxii)

cccxiii)

cccxiv)

cccxv)

cccxvi)

cccxvii)

cccxviii)

"i ure %&%: /efore Multilterl Nettin

#igure ,.-$ 6fter 7ultilateral Detting

7/21/2019 4th unit


cccxix)

cccxx)

cccxxi)

cccxxii)

cccxxiii)

cccxxiv)

cccxxv)

cccxxvi)

cccxxvii)

cccxxviii)

cccxxix)

cccxxx)

cccxxxi)

cccxxxii)

cccxxxiii)

cccxxxiv)

cccxxxv)

7/21/2019 4th unit


cccxxxvi%

cccxxxvii)

7/21/2019 4th unit


g@@fc 7anagement in 7ultinational &orporation` '4nit ,% "(-

cccxxxviii)

cccxxxix)

7/21/2019 4th unit


cccxl%

7/21/2019 4th unit


cccxli)

4th unit

Documents