MANAGING RISK IN INTERNATIONAL BUSINESS

1
MANAGING RISK IN INTERNATIONAL BUSINESS

• Techniques and Applications

2
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

3
Political Risk

• Definition
• Sources
• Assessment techniques

4
Modern Tools of Financial Decision Making

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

5
Shortcomings of Traditional Techniques

• Unsuited to modern financial decision making
• data
• parameters
• applications
• Generally imprecise and difficult to apply

6
The New Framework Overcomes These Shortcomings

• Uses market data (international prices)
• Generates parameters compatible with modern
  portfolio and option pricing theory

7
Generating the Data Four Steps

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

8
Important New Decision Making Parameters

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

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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

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New Parameters Examples

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

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A Big Question

• DOES IT WORK?

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CLARK vs .
EUROMONEYThe Forecast 1988

• The Clark forecast Euromoney, September 1988,
  page 234
• 60 countries
• The EUROMONEY forecast Euromoney, September
  1988, page 235
• 117 countries

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CLARK vs. EUROMONEYThe Result 1993
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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

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Performance Measurement

• INTERNATIONAL PORTFOLIOS

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Money Market Portfolios1982-1991
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Long Term Government Bond Portfolios1982-1991
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Equity Portfolios1982-1991
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Excess Return to Risk for Selected
Portfolios1982-1991
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Outline

• Brief review of traditional international risk
  analysis
• Presentation of new techniques
• Applications
• direct investment
• portfolio investment
• cross border loans