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Risks of direct Investment in Foreign Countries

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Introduction

The purpose of the study is to investigate the risks that a Company would be faced with the event of direct investment in a foreign country.  Economic and political risks are obvious guesses, but the study is covering specific segments of the economic and the political risks among others.

Political Risks

When investing in a foreign country an American company is exposed to the risks of a political nature. The political risk is incurred due to decisions made within the political arena. These decisions have the capacity to lead to unanticipated loss to investors. Political risks and decisions are most likely to be welcoming to a foreign investor. Due to the instability of some governments’ states, favorable conditions change all the time. Some of the changes result to unfriendly political climates that do not favor investment.

In the event where the investment has been made already, the changing political climate may affect a US company negatively however how economically stable a country is. The economy of a country may not be a factor to consider a risk when assessing the investment field. To come to terms with the economic stability of a country, the political climate is a key factor fueling the economy. With progressive economy foundation, a strong investment background by foreign companies is considered. Withdrawing from investing from a country may be a direct doing of the political powers and the immediate government.  If a  company is forced to withdraw its investment from a country it will possibly be faced by losses ranging from initial input to infrastructure and machinery purchases and installations (Perry 2011: 162) 

Financial Risks

Financial risks facing a US company investing to a foreign country are in the form of debts’ payment. The financial risks are also referred to as investment risks and are classified into several classes depending on different circumstances. The following are risks that are classified under the financial clause that may directly affect a US company’s investment in a foreign country.

Credit Risk: In the event a US company invests in a foreign country, the capital for investment may be a load on the company and this may lead to the company deciding to operate on credit borrowed grounds of labor, infrastructure and initial investment fee.  A credit risk is incurred in the US company does not make payments as promised to the parties involved. The debt is achieved in that the company incurs cost overruns and delay on schedule among other factors: the costs of settling the debts overrides the available revenues to pay interest and lower quantity of the debt. (Flyvbjerg, Bruzelius & Rotherngatter, 2003: 80)

Market Risk: US companies investing in a foreign country should be willing to incur market risks. These risks are posed in that the value of portfolio decreases due to changes of market risk factors. Market risk factors include Equity risk: risk a US company or any other company investing in a foreign would incur in which stock prices and implied volatility changes (Mann, 2005).

Interest rate risk: this risk involves changes in the interest rate of an investing company. Currency risk: the assets held by a US company on a particular foreign currency may be affected by the foreign exchange rates. Commodity risk: investing in a foreign country by a US company would be dependent on certain raw materials; change of prices of these raw materials will affect the finances of the company.

Operational Risks

Investing in foreign countries at some times is almost faced by the same challenges as those facing an investment company at its home country. Operational risks that a US investment company may face in a foreign country include fraud, legal, physical and environmental risks. The people working for the company could cause the operational risks, internal processes and systems. At a foreign country these operational risks are even in a broader scope than they would be in a home country.

The sources of operational risk are at times difficulty to identify and this leads to the risks being an unavoidable business cost. The risk can be managed but not put away altogether. So for every company investing at home its home country or at a foreign country should be able to manage the risk. For foreign investment risk is much pronounced than local investment, this is because of the market strategies and the governing rules for certain types of businesses. A foreign company operating in a foreign country may try to implement its home country business governing laws. However, the foreign country at which the company invests may impose their own business running regulations. The event of the two countries’ having contradicting regulatory guidelines could end up in legal risks. The underlying result of prevailing legal risks leads to a closure of the company or unfavorable business conditions.

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