University Finance: International Finance and Risk Management Report

This report provides a comprehensive overview of international finance, with a specific focus on foreign exchange (forex) risk and its management. It begins by defining exchange rate risk and its impact on multinational companies, emphasizing the volatility of exchange rates and the various factors influencing them. The report then delves into analyzing forex movements, illustrating how changes in exchange rates can affect investment returns and the importance of hedging strategies. It explores different methods for hedging investments, including investing in hedged assets, analyzing currency exposure, and utilizing derivatives like currency forwards, futures, options, and swaps. Furthermore, the report highlights various risks that multinational companies face, such as transaction, translation, and economic risks, along with political risks that affect overseas investments. The conclusion reiterates the importance of proactive risk management and strategic decision-making in the face of fluctuating exchange rates and global economic uncertainties.

Running head: INTERNATIONAL FINANCE
International Finance
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Introduction......................................................................................................................................2
Discussion........................................................................................................................................2
Analysing Forex Movement........................................................................................................2
How to Hedge Investment for Multinational Companies............................................................3
Risks Considerations are Important for Multinational Companies.............................................6
Conclusion.......................................................................................................................................9
References......................................................................................................................................11

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Introduction
Exchange rate or foreign exchange (forex) risk is an unavoidable risk for a foreign
investment, but the same can be mitigated with the help of the various derivatives hedging
strategies in order to reduce the impact of volatility in foreign currency. Exchange Rates are
volatile and changes due to various business and macro-economic factors that are directly
associated or that affects the performance of the currency. In order to eliminate the associated
foreign risk with the exchange rate an investors can use the various hedging instruments like the
usage and application of forwards, futures, swaps and options on the exchange rate in order to
mitigate or reduce the volatility or exposure of the portfolio (Iqbal 2017). There are various
business, political as well as macro-economic risks that is directly associated with the prevailing
exchange rate and any changes in these factors have a direct impact on the prevailing exchange
rate that in turn impact the volatility of the currency exchange rates.
Discussion
Analysing Forex Movement
Exchange rate can be well explained with the help of an example whereby an US
Multinational Company, is wanting to hedge exchange rate risk that is particularly important
when the US dollar is surging and the investment return can be materially affected due to
overseas return it becomes well important for the multinational company to take actions and
strategies for stabilizing the investment return. For overseas companies the reverse can be true
where the exchange rate of US is certainly rising and performing well (Ito et al., 2016). The
changes in the exchange rate can be well attributed to the depreciation of the local currency

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against the USD Dollar that in turn can provide extra added benefits to the investment returns. In
such type of situation where the exchange rate is going with company expectation and a strong
preemptive judgment is supporting the same the investors can go unhedged in this case. Macro-
economic risks including the changes in the interest rate, inflation rate and business cycle under
which the currency is taken into consideration changes then the same would be affecting the
performance of the exchange rate in the form of volatile exchange rates.
In the case of exchange rate hedging the common rule of thumb is to leave the exchange
rate risk in regard to the foreign investments unhedged when the local currency is depreciating in
against the foreign-investment currency, but it is equally important to hedge the forex risk when
the local currency is seen to be appreciating against the foreign investment currency (Álvarez-
Díez Alfaro-Cid and Fernández-Blanco 2016).
How to Hedge Investment for Multinational Companies
There are several ways in which the Investment or the Forex Risks can be hedged and the
same can be done by Multinational Companies in the following ways:

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 Invests in Hedged Assets: The easiest solution is to invest in a hedged overseas
assets whereby investment can be done in Hedged Exchange Traded Funds. The
ETF’s are available for a wide or variety of underlying assets that are traded in most
of major markets (Della Corte, Ramadorai and Sarno 2016). Many ETF’s providers
often provide hedged and unhedged versions of the funds that is in association with a
popular track of benchmark index where the investment is done. The costs associated
with the hedging in the context of ETF’s in this context can be of prime concern and
at same time it is also important that large EFT’S Funds can hedge the net asset value
of their fund at a very minimal amount. The MSCI EAFE Index that is traded in the
U.S and is acting as the primary benchmark for the U.S. investors for the purpose of
analyzing the performance of institutional equity investments – the expense ratio for
the undertaken IShares MSCI EAFE ETF (EFA) is around 0.32%.
 Hedging Exchange Rate Risks: Multinational Companies should undertake various
analysis of the portfolio including the assets or the currency with which the currency
is exposed and the resulting changes that can simultaneously affect the performance
of the company (Longinidis, Georgiadis and Kozanidis 2015). The analysis could be
better understood by the companies by breaking up with the classification in terms of
assets they are invested and how is the asset investment returns are directly correlated
with the performance of the exchange rates.

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 Instruments for Hedging the Currency Risk: Hedging the forex risk can be well
done by multinational companies with the help of the derivatives instruments
highlighted below:
 Currency Forwards: Forwards can be well used for the purpose of
mitigating the forex risk or the exchange risk associated with the investment.
If a multinational company operating in US is expecting a fall in the Euro
against the US dollar in the given trend period. The investor can hedge the
forex risk by entering into a forward contract to sell the Euro Dollar at the
associated one year forward rate (Breeden and Viswanathan 2015). The key
advantage and feature of the forward contract is that the contract can be
customized and entering into the forward contracts does not require any
deposit of the initial set of amount by the multinational company.
 Currency Futures: The currency futures can be well used by companies for
hedging the exchange rate risk via the futures contract that are traded on the
exchange and needs an small upfront premium that needs to be paid for the

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purpose of paying and entering into the futures contract. The aforesaid futures
contract are not customized rather they are standardized (Lan, Chen and
Chuang 2015).
 Currency Options and Swaps: Options stands out to be one of the best
possible sources of hedging where investor can buy or sell a specific option in
response to their assumption and belief about a specific currency in the
specific time period of option maturity (Chance and Brooks 2015). On the
other hand, swaps are customized contracts wherein one of the leg associated
with swap is kept fixed let’s say where one party would pay the prevailing
fixed interest rate in US and the other party would be paying the investment
return from EUR/USD Exchange Rate Return helping the both party exchange
their risk exposure.
Risks Considerations are Important for Multinational Companies
There are several risks that should be well considered for the purpose of analyzing the
impact of that risks on the net financial performance of multinational companies and the same

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can be well attributed to risks like exchange rate risks and political risk that affects the overseas
investment return and the overall investment return associated with a multinational company
(Papaioannou 2015). The key risks that could be faced by the Multinational companies can be for
the multinational companies in field like:
 Transaction Risks: Transaction risks are faced by companies in the stance when
company faces when it is buying a product from a company that is located in a different
country and the transaction would be done in a different currency. The associated price of
the product would be done denominated in the selling company currency. If the
associated selling company currency is expected to increase in contrast to the buying
company currency then the company will be ending up in making a payment that would
be much larger than in the base currency for the purpose of meeting the contracted price
(McNeil, Frey and Embrechts 2015).
 Translation Risk: Translation risk can be well inferred to the risk where a parent
company owning a subsidiary in another country can face translation currency where the
subsidiary company’s financial statement is listed in the local currency and the company

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parent company could face material risk when preparing or translating the financial
statement where changes in the exchange rate could materially affect the performance of
the parent company (Zhuang and Huang 2018). In the case of exchange rate hedging the
common rule of thumb is to leave the exchange rate risk in regard to the foreign
investments unhedged when the local currency is depreciating in against the foreign-
investment currency, but it is equally important to hedge the forex risk when the local
currency is seen to be appreciating against the foreign investment currency.
 Economic Risk: Macro-economic risks including the changes in the interest rate,
inflation rate and business cycle under which the currency is taken into consideration
changes then the same would be affecting the performance of the exchange rate in the
form of volatile exchange rates. If an US investor has invested into the European
Economy and if the prevailing inflation rate increases then the same would be hurting the
US investor in the form of lower investment return generated from the depreciated Euro
Dollar in contrast to the US Dollar (Danila and Huang 2016). On the other hand, similar
changes in the interest rate risks that are directly associated with the investment return
could be materially affecting the overall investment return for the investors. Thus, it is
very important to take into account various macro-economic risks that could potentially
affect the overall investment return that is associated with the investment done. The
changes in the exchange rate can be well described with the help of changing US Dollar
in contrast to Russian Ruble reflecting the appreciation or depreciation of the currency.

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 Political Risks: The key political risks that a multinational company can face in terms of
overseas investment and changes in the exchange rate can be well in the field of changing
business laws and regulations and other policies that would be directly affecting the
operations of the company and the overall investment return that is associated with a
specified currency. Any changes in the government laws and regulations that is
unfavorable for the current industry or sector may impact the business operations and the
international or overseas funding that the company used to receive as a financing activity
which in turn would get reduced due to the changing business policy and regulations.
Conclusion
Exchange Rates are volatile and changes due to various business and macro-economic
factors that are directly associated or that affects the performance of the currency. It is equally

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important for the multinational company to undertake various actions and strategies for the
purpose of forecasting and analysing the various factors or risks that can affect the financial
performance of multinational companies due to changing exchange rates.

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References
Álvarez-Díez, S., Alfaro-Cid, E. and Fernández-Blanco, M.O., 2016. Hedging foreign exchange
rate risk: Multi-currency diversification. European journal of management and business
economics, 25(1), pp.2-7.
Bandaly, D., Shanker, L. and Şatır, A., 2018. Integrated Financial and Operational Risk
Management of Foreign Exchange Risk, Input Commodity Price Risk and Demand
Uncertainty. IFAC-PapersOnLine, 51(11), pp.957-962.
Breeden, D.T. and Viswanathan, S., 2015. Why do firms hedge? An asymmetric information
model. The Journal of Fixed Income, 25(3), pp.7-25.
Chance, D.M. and Brooks, R., 2015. Introduction to derivatives and risk management. Cengage
Learning.
Danila, N. and Huang, C.H., 2016. The determinants of exchange rate risk management in
developing countries: evidence from Indonesia. Afro-Asian Journal of Finance and
Accounting, 6(1), pp.53-67.
Della Corte, P., Ramadorai, T. and Sarno, L., 2016. Volatility risk premia and exchange rate
predictability. Journal of Financial Economics, 120(1), pp.21-40.
Iqbal, J., 2017. Does gold hedge stock market, inflation and exchange rate risks? An econometric
investigation. International Review of Economics & Finance, 48, pp.1-17.