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Foreign Exchange Risk
Introduction
}Business whether it operates in the domestic or international arena is exposed to various movements in the currencies.
}The exchange rate fluctuations is termed as foreign exchange risk or foreign exchange exposure (Salleh, 2013).
}Volatility in the currencies can lead to adverse impact
Impact of Foreign Exchange on Companies
}Companies generate funds by borrowing debt or issuing equity (Mullings, 2018).
}The investment are majorly in the form of overseas assets and foreign currencies
}Domestic companies face risk
Depreciation of domestic currency implies that the payment of debt will cost more (Mullings, 2018)
Depreciation of Home currency
}Depreciation in the home currency means a fall in the value of the domestic currency
}Low worth as compared to USD $
}Exports cheaper
}Imports expensive
}Inflation
Impact on Interest payment
}Interest to be paid in foreign currency
}Weaker domestic currency implies more of domestic currency needed for the repayment
}Business and payment impact negatively (Spiceland et. al, 2011)
}Cost more domestic currency to repay USD $.
Economic Risk
}The depreciation of the home currency leads to economic risk
}Uncommitted cash flow pattern (Simon & Hillson, 2018)
}Additional burden on the home currency
}More level of debt
}Valuation of the currency is disturbed
Economic Risk
}The depreciation of the home currency leads to economic risk
}Uncommitted cash flow pattern (Simon & Hillson, 2018)
}Additional burden on the home currency
}More level of debt
}Valuation of the currency is disturbed
Lowering of Exchange rate
}Investor will demand more of other currency
}The valuation of other currency in question will increase
}Depreciation of the currency sends a negative signal
}Recession situation
Conclusion
}It comes to the forefront that the currency is always exposed and vulnerable to risks. Therefore, the firms, as well as the economy needs to have strong risk management approach to ward off the impending danger. This can be done through :
}Financial contract such as forwards, options, etc
}Operational mechanism like the geographic diversification (Simon & Hillson, 2018).
Bank Run – Definition and Features
- Customers Panic
- Customers start withdrawing their money
- This fear spreads like wild fire
- Banks run out of cash and faces sudden bankruptcy
Famous Bank Runs
Bank run generally occurs when customers start withdrawing their money because they fear bank is trouble. This is a herd instinct and all of a sudden all customers panic and this fear spreads like wild fire. This panic ensues resulting in stampede and even riots. The bank feels the crash crunch and run out of cash resulting in sudden bankruptcy. Although the financial institution can take some temporary measures to protect itself and it borrows cash from the Government or central banks but this panic kills the financial business. This psychological herd instinct influences the general decision and judgement of people. A bank run crashes the whole economy as it creates the dominoes effect – one bank knocking the other and ultimately the panic damages the entire economy of the nation (Market Business News, 2018).
Panic of 1907
- The panic of 1907 was caused by a blunder of Otto Heinze who was the brother of giant in the copper industry in America F. Augustus Heinze. Otto’s attempts to squeeze borrowed stocks of copper misfired terribly resulting in running both the brothers in bankruptcy of their brokerage house. The people were already feeling the brunt of recession and other economic problems due to the earthquake in San Francisco. The rumors that banks are in trouble spread, prompting frenzy of everyone. Ultimately J.P. Morgan and other banks took hold of the banking reigns and calmed down everything. This crisis gave birth to National Reserve Bank to handle such type of crisis.
The 1929 Wall Street Crash
- This was the greatest disaster in the history of Americans as it led to 12-years of Great Depression. This happened due to the crash in stock market caused by the concept of marginal purchase which means people who could not afford bought stocks on margin means with the help from brokerage. This means that people paid only 10% to 20% and the broker paid 80% to 90%. On March 25, 1929, the market dipped and people panicked as they received margin calls. This was the warning bell which was followed by Black Thursday on October 24, 1929, Black Monday, and Black Tuesday was the apocalyptic day when shares worth 16.4 million were sold resulting in impending major crash. The aftershocks of this lasted for more than two years. People lost trust in bank and several people committed suicides due to the losses.
The Argentinian Debacle
- The rampant corruption in the Argentina government increased debts resulting in revaluation of currency exchange which led to perpetual halt of exports. This was followed by mass unemployment and increased inflation. People loss faith and this caused massive bank run (WealthHow, 2018).
Causes of Bank Runs
- Individual liquidity stock -Individual suffers liquidity shock due to loss of earnings, health issues, natural disasters, etc.
- Bad loans- All investments are not successful. When borrowers do not return their loans
- Bank Losses- Bank incurs losses due to lack of internal funds. Bank becomes a borrower.
There are three main reasons of bank run are as follows (Lee, 2002):
- Individual Liquidity Shock: the depositors suffer losses like hospitalization fees, loss of earnings, or other untoward incident and as a result withdraw huge chunk of deposits. During natural disasters, many depositors withdraw all at a time resulting in bank crisis and ultimately end in bank run.
- Bad Loans: when banks fail to recover the initial principle amount due to bad loans, results in creating a bank run. Not all loans are good loans. Very often borrowers do not repay their loans resulting in crash crunch.
- Bank Losses: banks do not run on depositors fund. They have their own internal fund to run the bank like paying salary, rent, etc. if banks do not have internal fund to run the banks, they become borrowers leading to vicious cycle and ending in bank run.
Techniques to Prevent Bank Run
- Slow it down
- Borrow Money
- Insure People’s Deposits
Banks run on depositor’s money and if depositors withdraw money all at a time even a sound financial institution can sin.
Bank run can be prevented in three ways discussed below (NPR, 2012):
- Slow it down: Allowing tiny withdrawals can help to slow down the bank run. In extreme cases banks shut down to prevent pulling off the money
- Borrow Money: In a bank run people panic and run for withdrawing their money. In such instances, banks can borrow money to prevent the run
- Insure people’s deposits: Insurance of the deposits has ended bank runs. It is a promise, an insurance that banks give that even if it runs out of money, it will pay back their customers
Biggest Bank Run in U.S. History
- On Thursday September 2, 2008, U.S. economy imploded in just 5 hours.
- Panicked depositors sucked out money
- $4.5 billion were pulled out of the system every minute
The recent and the biggest bank run took place On Thursday September 2, 2008 in USA. Around $4.5 billion were pulled out of the system every minute by the depositors. As a result of this U.S. economy imploded in just 5 hours (Livingstone, 2017).
Human Psychology of Bank Run
- It is misleading to describe bank run as psychological.
- The course of action taken by people in bank run is natural and not panicky
- Reassurance and communication inadvertently create a bank run
Masses of people withdrawing monies are considered as bank run and generally this behavior is termed as ‘mass panic’. But, Psychologists believe that this behavior is natural and not panicky. This is because people’s behavior is orderly and quite calm which is not the case in panicky situation. People cooperate and control their emotions. Furthermore, this course of action that people adopt is the most natural action. In such cases, communication or giving reassurances simply backfires because people lose confidence and trust in the banks and financial institutions (Drury, 2015).
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