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Assessing Currency Risk and Investment Strategies in International Finance

Examines methods for managing currency risk in international investments.

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    Assessing Currency Risk and Investment Strategies in International Finance, page 1Assessing Currency Risk and Investment Strategies in International Finance1.How does borrowing in foreign currency expose multinational corporations (MNCs) toexchange rate risk, and what are the key strategies or hedging tools available to managethis risk?Discuss the challenges and effectiveness of these strategies in minimizing exposure to exchangerate fluctuations.Answer 1In my view, when an MNC borrows a foreign currency, they are essentially speculating on futureexchange rate movement. The cost of borrowing currency depends upon the interest rateprevailing in the market if currency is lent on floating interest rate. Even fixed interest rate ischarged in accordance with the movement in interest rate.Therefore, for borrower, interest raterisk in always inherited in loan. When borrowing involves the foreign currency then one risk addon-exchange rate risk. Borrowing in foreign currency is a kind of speculating on futureexchange rate movements.Giovanni, Luc and Robert (2011) stated that when firms borrow in theforeign currency, they becomeexposed to exchange rate risk.In particular, in case of a sharpdepreciation of the domestic currency, they may be unable to repay theirloans even though iftheir projects are successful (this is because the project is still run domestically,so the return y isdenominated in the domestic currency, but the repayment rL is in the foreigncurrency).Ifexchange rate is favorable to the borrower then itis cheaper to borrow foreign currency butfavorable exchange rate is not a static picture. Exchange rates are subject to move in effect ofdifferentmacro economic factors. It is very difficult to precisely know the trend of exchange ratemovement and therefore, demand high level expertise to get close to the actual trend of exchangerate. It result an exchange rate exposure to the borrower.

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