MANAGING RISK IN INTERNATIONAL BUSINESS

Techniques and Applications

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

The Three Steps to Effective International Risk Management

Identify

the individual risks Assess risk magitudes and exposure levels Incorporate the risk assessment in the decision making process

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Political Risk
Definition
Sources Assessment

techniques

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Modern Tools of Financial Decision Making

Required

input: MARKET DATA

Mean-variance analysis Contingent claims analysis Modigliani-Miller

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Shortcomings of Traditional Techniques

Unsuited

to modern financial decision making

data parameters applications

Generally

imprecise and difficult to apply

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

The New Framework Overcomes These Shortcomings

Uses

market data (international prices) Generates parameters compatible with modern portfolio and option pricing theory

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Generating the Data: Four Steps

Establish

accounting discipline Define income flows Define expenditure flows Link income and expenditure to the balance sheet

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Important New Decision Making Parameters

Macroeconomic

profits Market value of the economy The economys rate of return The economys financial risk premium The economys systematic risk (beta)

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Assessing Country Specific Financial Risk

Estimate

standard deviation of country rate

of return Estimate total amount of foreign debt and its duration Apply the information in the Black-Scholes option pricing formula
Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

New Parameters: Examples

The

financial risk premium Insolvency or illiquidity The maximum debt level Implied volatility

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

A Big Question

DOES IT WORK?

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

CLARK vs . EUROMONEY The Forecast 1988

The

Clark forecast: Euromoney, September 1988, page 234

60 countries

The

EUROMONEY forecast: Euromoney, September 1988, page 235

117 countries

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

CLARK vs. EUROMONEY The Result 1993

Exhibit 6.9 - Percent of Unrescheduled Debt at Each Rank 1 0,8 0,6 0,4 0,2 0 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57

Clark

Euromoney

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Estimating Systematic Risk

Construct

the World Index

Estimate macroeconomic market value for each country Sum the market values of all countries to create the world index
Regress

country returns against percentage change in world index to estimate Beta

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Performance Measurement

INTERNATIONAL PORTFOLIOS
Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Money Market Portfolios 1982-1991

Optimized GDP weights Equal weights Jap-Ger-Switz Arithmetic. mean Geometric mean Standard deviation Return/SD 13% 12% 11.8% 11.0%

12.7%

11.2%

11.1%

9.9%

7.5%

13.3%

12.4%

15.7%

1.733%

0.902%

0.952

0.701%

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Long Term Government Bond Portfolios 1982-1991

Optimized GDP weights Equal weights Jap-Ger-Switz Arithmetic mean Geometric mean Standard deviation Return/SD 14% 12.4% 12.5% 11.8%

13.5%

11.6%

11.8%

10.8%

11%

13.2%

13.2%

15.7%

1.273%

0.939%

0.950%

0.753%

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Equity Portfolios 1982-1991

Optimized Equal weights with US 15.89% Equal weights without US 16.77% Jap-Ger-Switz Arithmetic mean Geometric mean Standard deviation Return/SD 20.11% 17.45%

17.44%

14.2%

14.83%

14.92%

25.56%

20.64%

22.08%

25.85%

0.7868%

0.76.99%

0.7596%

0.6750%

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Excess Return to Risk for Selected Portfolios 1982-1991

Optimized Money market LT govt. bond Equity index 0.700 0.567 0.484 Equal Weights 0.331 0.364 0.409 Jap-Ger-Switz 0.210 0.261 0.375

Source: E. Clark, A general International market index, International Journal of Finance, vol. 3, (1995) 1288-1312

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr

Outline
Brief

review of traditional international risk analysis Presentation of new techniques Applications

direct investment portfolio investment cross border loans
Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr