International Risk

International business is extremely lucrative, more so today than in the past. A large part of this is due in part to the advantages of the internet and the lines of communication that open up. Previously only large corporations were able to effectively deal in the international market but today more small businesses are getting their business' launched into the international markets. However, engaging in these international markets comes with some risks, but there are tools to manage this risk in international finance.

The biggest risk in international finance is exchange rate risk as this is something that occurs and fluctuates daily even hourly and can make transactions more or less profitable instantly. "For a large multinational firm, the management of exchange rate risk is complicated by the fact that there can be many different currencies involved for many different subsidiaries. It is very likely that a change in some exchange rate will benefit some subsidiaries and hurt others. The net effect on the overall firm depends on its net exposure." (Ross, Westerfield, & Jordan, 2003, Chapter 18.5) Businesses small and large need to prepare and know how to best conduct business internationally as well as handle indirect economic currency exposure. This indirect economic currency exposure arises from unexpected movements in foreign exchange rates changing the competitive situation of the firm and which affect the firm's future cash flows (and hence value). (Buckley & Casson, 1992)

There are three types of exchange rate risks a company needs to consider when handling international finance: short-run exposure, long-run exposure and translation exposure. Short-run exposure is the day-to-day transactions that involve buying and selling goods on set prices thus allowing for some risk as rates change. Long-run exposure would be changes that happen to the foreign economy as a whole, changes in labor rate or markets can offset or even negate any benefit of maintaining business in that country. Translation exposure occurs mainly on the accounting side of the business when difficulty in handling gains or losses on exchange rate fluctuations as well as maintaining the proper exchange rate to use when converting transactions from foreign amounts to US dollar amounts.

Another aspect of international finance is handling the trading of currencies as there are two parts, the spot market and the forward market. The spot market consists of transactions to be completed quickly, generally in the time span of two business days. The forward market is the price negotiated at the time the transaction is agreed upon while the actual exchange or delivery will take place some time in the future. While the price, payment method, terms are all determined in advance, no exchange of money takes place until the settlement date. This commitment holding both parties to a previously agreed exchange rate is referred to as a forward contract. Forward contracts are common international business practice and are used to limit exposure to losses. One problem is that these contracts require future results and sometimes those obligations go unmet thus leaving both parties at a loss.

"Firms can minimize their foreign exchange exposure through leading and lagging payables and receivables - that is, collecting and paying early or late depending