bec doms ppt on managing risk in international business

MANAGING RISK IN INTERNATIONAL BUSINESS

The Three Steps to Effective International Risk Management

Identify the individual risks Assess risk magitudes and exposure levels Incorporate the risk assessment in the

decision making process

Political Risk

Definition Sources Assessment techniques

Modern Tools of Financial Decision Making

Required input: MARKET DATA Mean-variance analysis Contingent claims analysis Modigliani-Miller

Shortcomings of Traditional Techniques

Unsuited to modern financial decision making data parameters applications

Generally imprecise and difficult to apply

The New Framework Overcomes These Shortcomings

Uses market data (international prices)

Generates parameters compatible with modern portfolio and option pricing theory

Generating the Data: Four Steps

Establish accounting discipline Define income flows Define expenditure flows Link income and expenditure to the balance

sheet

Important New Decision Making Parameters

Macroeconomic profits Market value of the economy The economy’s rate of return The economy’s financial risk premium The economy’s systematic risk (beta)

Assessing Country Specific Financial Risk

Estimate standard deviation of country rate of return

Estimate total amount of foreign debt and its duration

Apply the information in the Black-Scholes option pricing formula

New Parameters: Examples

The financial risk premium Insolvency or illiquidity The maximum debt level Implied volatility

A Big Question

DOES IT WORK?

CLARK vs . EUROMONEY

The Forecast 1988 The Clark forecast: Euromoney, September 1988, page 234 60 countries

The EUROMONEY forecast: Euromoney, September 1988, page 235 117 countries

CLARK vs. EUROMONEYThe Result 1993

0

0,2

0,4

0,6

0,8

1

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57

Exhibit 6.9 - Percent of Unrescheduled Debt at Each

Rank

Clark

Euromoney

Estimating Systematic Risk

Construct the World Index Estimate macroeconomic market value for each

country Sum the market values of all countries to create

the world index

Regress country returns against percentage change in world index to estimate Beta

Performance Measurement

INTERNATIONAL PORTFOLIOS

Money Market Portfolios1982-1991

Optimized GDP weights Equal weights Jap-Ger-Switz

Arithmetic.mean

13% 12% 11.8% 11.0%

Geometricmean

12.7% 11.2% 11.1% 9.9%

Standarddeviation

7.5% 13.3% 12.4% 15.7%

Return/SD 1.733% 0.902% 0.952 0.701%

Long Term Government Bond Portfolios1982-1991

Optimized GDP weights Equal weights Jap-Ger-Switz

Arithmeticmean

14% 12.4% 12.5% 11.8%

Geometricmean

13.5% 11.6% 11.8% 10.8%

Standarddeviation

11% 13.2% 13.2% 15.7%

Return/SD 1.273% 0.939% 0.950% 0.753%

Equity Portfolios1982-1991

Optimized Equal weightswith US

Equal weightswithout US

Jap-Ger-Switz

Arithmeticmean

20.11% 15.89% 16.77% 17.45%

Geometricmean

17.44% 14.2% 14.83% 14.92%

Standarddeviation

25.56% 20.64% 22.08% 25.85%

Return/SD 0.7868% 0.76.99% 0.7596% 0.6750%

Excess Return to Risk for Selected Portfolios1982-1991

Optimized Equal Weights Jap-Ger-Switz

Money market 0.700 0.331 0.210

LT govt. bond 0.567 0.364 0.261

Equity index 0.484 0.409 0.375

Source: E. Clark, “A general International market index”, International Journal of Finance,vol. 3, (1995) 1288-1312

Outline

Brief review of traditional international risk analysis

Presentation of new techniques Applications

direct investment portfolio investment cross border loans