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FUNCTION A: EXPOSURE MANAGEMENT

5 November, 2015 - 14:33

Risk managers are confronted with two types of risk: commercial risk and macroeconomic risk. Within the category of commercial risk are industry specific risk and firm-specific risk. Industry-specific risk is caused by uncertainty about the demand for one industry's products relative to that for other industries' products. Firm-specific risk, on the other hand, arises as a result of uncertainty about the demand for a firm's specific product relative to that for other firms' similar products. These two forms of risk are addressed in standard financial management texts.

The three types of macroeconomic risk to which every MNC is exposed are listed in Figure 12.3. Financial risk refers to the magnitude and likelihood of unanticipated changes in interest rates and costs of different sources of capital in a particular currency. Currency risk refers to the magnitude and likelihood of unanticipated changes in the value of foreign and domestic money; it encompasses exchange rate risk and inflation risk. Country risk (including political risk) refers to the magnitude and likelihood of unanticipated changes in a country's productive development and "rules of the game," such as tax laws, investment incentives, and business climate.

Figure 12.4illustrates the causal chain that links the sources of risk to the effects on the firm's cash flows. The sooner a manager recognizes a potential disturbance, the easier it is to convert it into an anticipated event for which a remedy can be found. A corollary to this rule is that MNCs must be risk averters. For example, management must be willing to pay money to protect the firm's assets from exchange rate risk, discussed in the next section.