Business finance : theory and practice

Chapter 15 • International aspects of business finance
abnormal gains by trading in currencies. The same general factors seem to apply.
There are lots of intelligent people studying the market closely and seeking profitable
opportunities. They have access to the capital to exploit any anomalies and make a
profit. In one significant respect, however, the foreign exchange and the secondary
capital markets differ. This is that governments tend not to intervene in the secondary
capital market, whereas governments sometimes, perhaps frequently, intervene to a
significant extent in the foreign exchange market. This is done in an attempt to manage
the exchange rate in some way.
Knowing that a government, or governments, have a particular exchange rate
objective can enable speculators to predict what will happen in the foreign exchange
market. The evidence seems to bear this out. Studies show that where there is a clear
government policy never to intervene in the market, that is, where the currency is
allowed to ‘float’ freely, the markets seem to be efficient. Where governments have a
known policy, such as raising interest rates, or buying their currency in the market, to
support its value, the evidence shows that the market is not efficient.
15.3 Problems of internationalisation
So far we have seen that businesses generally should benefit from taking an international
perspective on all aspects of their activities. We have also looked at how the foreign
exchange markets work, and at some theory and evidence of the factors that seem
to affect the determination of exchange rates. We shall now go on to look at some of
the problems involved with operating at an international level, and at how some of the
risks can be eliminated or contained.
Problems with foreign exchange
Any business that trades in foreign markets is almost compelled to exchange currency
as part of its day-to-day routine. The existence of problems surrounding foreign
exchange is the spur to countries seeking to peg currencies against those of countries
with whom they frequently deal, or adopting a common currency, as many of the EU
countries have done with the euro.
The most obvious problem that confronts such businesses is the cost of foreign
exchange dealing. When a business sells to a foreign buyer, usually payment will be
in the currency of the buyer’s country. Some part of the value of the sales proceeds
will be lost to the foreign exchange market. In percentage terms this is not a very large
figure, but it is a cost.
Exchange rate risk
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Exchange rate risk is the risk that the rate of exchange between two currencies will
move adversely to the particular business under consideration. A change in exchange
rates can have the effect of reducing the business’s wealth. Similarly, it can increase its
wealth, where the change is favourable, given the type of exposure.
Exchange rate risk can be broken down into three areas: transaction risk, economic
risk and translation risk.
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