Considerations of Global Capital Investment

Operating exposure occurs when a firm becomes vulnerable to sudden shifts in the foreign currency exchange rates or a rapid decline in the value of one currency against another. If the value of a firm’s assets is measured in terms of the currency value of a particular country’s medium of exchange, then it is vital that the cash flow from foreign currencies maintains a reasonable comparable worth to that of the primary currency. The sharp decline is the value of a particular currency in which a firm receives payment can create a cash flow shortfall for the firm. This will, in turn, diminish the overall value of the firm’s assets and increase the risk to investors thereby creating a still greater cash flow problem. When a particular nation experiences a severe economic downturn, such as the recession the United States has experienced since 2008, the value of that nation’s currency will diminish. The U.S. dollar has lost nearly a third of its value in the euro-dollar exchange over the past five years. This negatively impacts international firms that are paid for their goods, labor, and services in U.S. currency. International investors are deterred from accepting payment in U.S dollars because of this (Levi, 2005).

Market segmentation will happen when a firm attempts to penetrate a large international market in a multiplicity of ways that are oriented to various sub-groups of potential customers. Many American firms have penetrated international markets on a large scale, including the European Union nations and the domestic market of China, where the currency and economic policy are favorable. However, this market penetration has been broken down into segments oriented towards the consumption of various American export products. Segmented markets exist for the exportation of American fast-food chains, popular music, clothing styles, film and television entertainment, and many other things. Potential customers for these commodities are identified in relation to smaller markets than the single domestic market of a particular region or nation. Popular music or clothing styles may be aggressively marketed to younger demographics within a broader market while restaurant hospitality may reflect a greater cross-section of the age, class, and cultural dynamics contained within a larger market area (Keller, Kotler, 2006).

As firms venture into ever-larger international markets, the method of pricing capital assets takes on new dimensions. Multiple factors emerge which are less significant within the context of a domestic market but which become vital when dealing with international markets. The aforementioned risk associated with operating exposure is one of these. A potential investor will determine the potential value of a prospective investment not only on the return he expects to generate within a particular time frame. He will also expect a greater return for having assumed the greater risks associated with investment in international markets (Moosa, 2003).

More generally, international markets require a greater degree of flexibility within a firm in order to manage challenges that will be more varied and unpredictable than they normally would be in a singular domestic market. An investor or financial manager within a firm must compare the relative stability of various national economies and the resulting shifts in currency values (Dunn, Mutti, 2004).

Operating exposure may be managed in several ways. One of these is through back-to-back parallel loans. A firm in one nation will make a loan through one of its international subsidiaries to a firm in another nation. The parent firm in the other nation will then reciprocate. Each firm then acquires a reserve in the currency of the other firm.

An alternative is to arrange a currency swap. Two firms will simply trade funds within their respective national currencies and then pay interest on their respective loans to one another for a period of time before mutually transferring the funds back to the party from whom they were received (Pilbeam, 2006).

References

Dunn, Robert M., Jr. and John H. Mutti (2004). International economics (6th ed.) New York, NY: Routledge.

Keller, Kevin Lane and Philip Kotler (2006). What is geographic segmentation? Marketing management. Upper Saddle River, New Jersey: Prentice Hall.

Levi, Maurice D. (2005). International finance (4th ed.) New York, NY: Routledge.

Moosa, Imad A. (2003). International financial operations: Arbitrage, hedging, speculation, financing and investment. New York, NY: Palgrave Macmillan.

Pilbeam, Keith (2006). International finance (3rd ed.). New York, NY: Palgrave Macmillan.