Module 05 Course Project - Presentation

Risk Identification

Yomarie Miranda

Rasmussen College

03/08/2019

Introduction

International expansion is an important decision that the management of an organization will have to make when it comes to meeting the expansion missions or goals of their organization. Companies going public for the first time, like Gentry Inc are at higher risks when it comes to internationalization as compared to bigger companies. There are various risks that the company shall face in its international expansion strategy, which will be of utmost importance for the directors to discuss. Gentry Inc qualifies to take an initial public offering as dictated by the regulations of the Securities Exchange Commission. The company plans to expand to China, Japan and Germany, to increase its profitability by a margin of 15 to 25 percent. However, the company is likely to face various risks in its endeavors as shown below.

Transaction Risk

The transaction risk I s describes as the risk on the exchange rate that is associated with a time delay between entering into a business agreement and settling the agreement. It is most common in international firms that have to deal with different currencies. The longer the time before settlement of an agreement the higher the risk involved (Ekeha, 2009). Gentry Inc will be based in three different countries if the expansion strategy goes well. The above means they will be dealing with three different currencies. The exchange rate market is very volatile and changes drastically within short periods of time. Transactions made by the company in one currency will have to be converted to the base currency. If the currency pair such as the dollar (USD) and the Japanese Yen fall. It might affect the company causing a loss due to the transaction risk. The best way that Gentry Inc can prevent such losses during business transactions in different countries is through use of hedging mechanisms such as forward contracts and purchasing options.

Sensitivity analysis- In the above case, we shall use the analysis to see what effect a fall in currencies would have on the company. If Gentry Inc is dealing with profits in Germany, it will have let's say, 1,000,000 Euros. That will result to 1,179,127 USD if the transaction is settled immediately. However due to a delay in the settlement the USD devaluates against the Euro, by one dollar, changing back the dollars to Euros, the company will have fewer Euros than before which is a loss caused by transaction risk. Based on the rate of fluctuations the company can be able to calculate its transaction risks.

Translation Risk

When Gentry Inc goes international, it will denominate some of its assets, equities, liabilities and incomes in the foreign currency, such as the Yen, Euro or CYN. The value of these assets will change as a result of changes in the exchange rates (Li, Zhu & Li, 2016, p. 105-120). It is commonly referred to as the accounting risk. The risks lead to what is seen as a financial loss or gain in the balance sheets of the company. Gentry might, for example, have a property in China worth CYN 1 million, with a current dollar to CYN ration of 1:1, giving an equal valuation of $ 1 million. If the exchange rate fluctuates and the ratio becomes 1:2, it means that the asset will be reported to have a value of 500,000 dollars. On the balance sheet, it would show a loss of half the value of the property even though the property is the same one as before.

Gentry Inc in case of such a scenario should use hedging techniques such as currency swaps and currency futures to deal with the risk.

Economic Risk

Economic risks are associated with the microeconomic environment is a country. Multinational enterprises face economic risks as they invest their portfolios in different countries. Economic risks evident in different countries include government regulations, political stability in a country, the exchange rate as governed by the Central Bank of the country. Gentry Inc is investing in foreign countries that have different economic environments compared to its home country. Political risks will affect the profits and operability of the company in other countries. For instance, China is a good market but has political tension where politics is involved in business practices. If there is political war in a country like Japan, it might be a disadvantage to Gentry in that its activities will be hindered (Vahlne & Johanson, 2017).

Governments in different countries also put strict regulations on foreign firms as they try to protect their infant industries. Gentry will have to find a way to go round such regulations and weigh the benefit and risks associated with the different countries and make the best decision. Volatile exchange rates in the three different countries will also affect the firm's profitability (Dlabay and Scott, 2011). Gentry Inc can minimize economic risks through diversification of its portfolios in the countries.

Sensitivity Analysis

Gentry Inc's financial analysts can use the sensitivity analysis or the What-If analysis to predict the outcome of certain actions taken under certain conditions in the three potential countries. For instance, the company can use the analysis to predict the effect of transaction risks in the three countries.

The advantage of the above analysis is that it adds credibility to financial models by testing through a wide range of possibilities. It also allows flexibility and helps make informed choices (Hasegawa & Small, 2017).

Scenario Analysis

The financial analysts can use the method describing in detail, certain scenarios in a given country, associated with a certain risk. Analyzing major shocks such as market shifts and business changes is best done using the above analysis.

The advantages of the strategy are that it encourages creativity and long-term business planning. It also questions business assumptions and complements strategic planning. The disadvantage is that the model can be user biased (Chen & Hu, 2017, p. 26-29).

Conclusion

Gentry Inc should consider all the risks involved in going international before investing in the three countries. It should also understand each risk and the effect they have on the profitability of the company. If some of the risks in different potential countries are uncontrollable, it should find greener pasture to ensure that its growth objective is attained. Transaction, translation and economic risks are at times inevitable but can be mitigated.

References

Chen, Y., & Hu, Y. (2017). Set-valued risk statistics with scenario analysis. Statistics & Probability Letters, 131, 25-37. doi: 10.1016/j.spl.2017.08.004

Dlabay, L., & Scott, J. (2011). International business. Mason, OH: South-Western Cengage Learning.

Ekeha, G. (2009). Evaluation of Hedging Techniques as Instruments to Minimise the Impact of Transaction and Translation Risks in Global Business Market. SSRN Electronic Journal. doi: 10.2139/ssrn.1728827

Hasegawa, R., & Small, D. (2017). Sensitivity analysis for matched pair analysis of binary data: From worst case to average case analysis. Biometrics, 73(4), 1424-1432. doi: 10.1111/biom.12688

Li, G., Zhu, J., & Li, J. (2016). Understanding bilateral exchange rate risks. Journal Of International Money And Finance, 68, 103-129. doi: 10.1016/j.jimonfin.2016.07.008