Exchange Rates Volatility and Risks Essay

thither be a number of factors that could change the value of a currency with respect to another. If the pompousness respect in a country is low with respect to the ostentatiousness charge per unit in other countries, the prices of goods and services in the country with the low inflation lay become attractive for irrelevanters. However, increases in imply for the goods and services in the country with a low inflation rate are expected to prize the value of the countrys currency (Ana, FS 2004). Changes in interest rank tend to have a similar affect on exchange rates. Foreigners would want to invest in countries where the rates of return on investment are high.As the demand for investment in a particular country increases because it enjoys a high interest rate in comparison with other countries the value of its currency is expected to appreciate (Ana, FS). The exchange rates at a apt(p) time are also dependent on differences between the occurrent account balances of coun tries. If a country is running a current account deficit, it loosely means that the country is importing more than it is exporting, so therefore investments in the country whitethorn not be considered lucrative. A country with a current account surplus, on the other hand, is considered attractive for investment.As a matter of fact, the currency of this country is as attractive to foreigners as its products and services. By increasing their demand for the countrys products and services, foreigners are expected to appreciate its currencys value. As its currencys value appreciates, however, investing in the country becomes little affordable (Ana, FS). When a country is experiencing a current deficit, its government may decide to borrow money to finance the self same deficit. Inflation may ensue. Moreover, if the lenders believe that there is a default risk, they may decide to sell off the debt on the open market.In the United States, treasury securities may be used for this reason. I n any case, the selling of the debt on the open market is expected to exert downward pressure on the foreign exchange rate (Ana, FS). Exchange rates are also affected by the political climate of a country at any given time. Political overturn in a country may result in a loss of investor confidence in its currency. Conversely, countries that enjoy relatively stable political climates are able to attract investment and experience appreciations in the values of their currencies (Bergen, JA 2007).Undoubtedly, a firm moldiness be able to manage the different kinds of political risks that it may have to face by investing in a particular country. There are three main types of political risks firm-specific risks, country-specific risks, and global-specific risks. Of the three types of political risks, firm-specific risks complicate the volatility of exchange rates. These risks are expected to affect the multinational enterprise at the corporate and/or project level (Frenkel, M, Karman, A , & Scholtens, B 2004). For this reason, an exchange rate risk or currency risk from the perspective of an American investor is defined as followsThe risk that a business operations or an investments value will be affected by changes in exchange rates. For example, if money must be converted into a different currency to grant a certain investment, changes in the value of the currency relative to the American dollar will affect the total loss or gain on the investment when the money is converted back. This risk usually affects businesses, but it can also affect individual investors who make international investments (Exchange Rate Risk 2007). There are three types of exposure to exchange rate volatility that an investor may have to confront.The firm faces translation exposure when its reported accounting profits must be adjusted as a result of foreign exchange rate fluctuations. Transaction exposure is the result of the firms agreement to admit certain foreign exchange transactio ns during the current period (Bolster, P 2006). As an example, an importer may sign an agreement to purchase a specific meter of goods from commonwealth A and pay a certain amount of money to the country in ninety days. Through this agreement the importer is obligated to pay Country A by purchasing the units of Country As currency in ninety days.Seeing that the exchange rate may change in ninety days, the importer is exposed to currency risk (Bolster, P). Lastly, investors may have to face economic exposure to exchange rate volatility. This type of exposure to exchange rates volatility results from the need of the firm to conduct business activities in another country in future. Bolster, P describes economic exposure as the need for foreign exchange transactions and exposure to exchange rate fluctuations that results from future business activities. The experience of Toyota in the U. S. utomobile market helps to explain this type of exposure to exchange rate volatility. The compa ny had managed to attain a sizeable market share in the United States. But, when the Japanese yen started to appreciate in relation to the U. S. dollar, the revenues of the company dropped importantly (Bolster, P). The good news is that it is possible for investors to manage the political risks, including the firm-specific risks that they may be exposed to. Limiting, diversifying, and hedging are all viable methods of managing political risks (Frenkel, M, Karman, A, & Scholtens, B p. 20).