some recommendations to strengthen risk management at COMA-IMEX

International payment nowadays is very important yet risky. Risk management is issue which managers pay much attention to, especially managers of import-export firms. The purpose of this study is to detemine the financial risks and commercial risks which COMA-IMEX, an import-export enterprise now facing with and what feasible solutions COMA-IMEX should take to solve them. The report is divided into four chapters. In chapter 1, the researchers give a brief presentation on the establishment and development of Construction Machinery Import Export Center (COMA-IMEX) and introduction about their functions, missions and the company’s structure. In additions, there are overview of risk management at COMA-IMEX in recent years. In chapter 2, the researchers present theoretical framework which is supported to the report. This chapter covers key terms and definitions of risk management, types and classification of risks, etc. Then, in chapter 3, by doing research of financial status and business statement of COMA-IMEX, the researchers gives comments on reality of import/export business at COMA-IMEX as well as COMA-IMEX’s achievement and failures. Finally, in chapter 4, the researchers makes some recommendations to strengthen risk management at COMA-IMEX

TABLE OF CONTENTS

TABLE OF ABBREVIATIONS i

TABLE OF FIGURES ii

EXECUTIVE SUMMARY iii

INTRODUCTION 1

1 Introduction of the research topic 1

2 Purpose and scope of the research 1

3 Research questions 2

4 Methodology 2

CHAPTER 1: INTRODUCTION 3

1.1 An overview of COMA-IMEX 3

1.1.1 History and development of COMA-IMEX 3

1.1.2 Functions and missions 3

1.1.3 Organizational structure 4

1.2 Overview of risk management in international payment at COMA-IMEX 5

1.2.1 International payment reality in recent years 5

1.2.2 Reality of risks at COMA-IMEX 6

CHAPTER 2: THEORETICAL FRAMEWORK 8

2.1 Key terms and definitions 8

2.1.1 International payment 8

2.1.2 Risks 8

2.1.3 Risks in international payment 9

2.2 Commercial risks 9

2.2.1 Risks to sellers 10

2.2.2 Risks to buyers 10

2.3 Risks in payment (financial risks) 12

2.3.1 Credit risk 13

2.3.2 Country risk 13

2.3.3 Legislative risk 15

2.3.4 Foreign exchange risk 15

2.3.5 Interest rate risk 16

2.3.6 Risk of selecting unsuitable conditions while negotiating international payment terms 18

CHAPTER 3: FINDINGS AND ANALYSIS 19

3.1 Business results in recent years 19

3.1.1 Reality of financial general status and business operation at COMA-IMEX 19

3.1.2 Overall assessment of COMA-IMEX’s real situation of international payment 21

3.2 Reality of risk management at COMA-IMEX 24

3.2.1 Types of risks which COMA-IMEX often faced with 24

3.2.2 Preventive solutions to risks which have been used so far at COMA-IMEX 27

3.3 Overall assessment of risk management in international payments 29

3.3.1 Achievements 29

3.3.2 Failures 30

CHAPTER 4: RECOMMENDATION 31

4.1 Suitable methods of payment 31

4.2 Suitable currency in payment 31

4.3 Payment methods diversification 32

4.4 Choosing partners 32

4.5 Human resources 33

4.6 Relationship with banks 34

4.7 Selecting and negotiating import/export contract conditions 35

4.8 Strengthening COMA-IMEX’s business and position 35

4.9 Others 36

CONCLUSION 37

REFERENCES

TABLE OF ABBREVIATIONS

COMA-IMEX Construction Machinery Corporation – Import Export

Centre

Incoterms International Commercial terms

UCP The Uniform Customs and Practice for documentary

credits

ISBP International Standard Banking Practice

CIF Cost & Insurance & Freight

TABLE OF FIGURES

Table 1 – Business statistics at COMA-IMEX from 2009-2011 19

Chart 2 - Main sources of revenue at COMA IMEX (2009-2011) 21

Table 2 – Prime cost in USD and JPY (2009-2010) 22

Table 3 – E/R percentage of COMA-IMEX from 2009-2011 22

Chart 3 - Percentage of Sales from import/export 23

The report is divided into four chapters

In chapter 1, the researchers give a brief presentation on the establishmentand development of Construction Machinery Import Export Center (COMA-IMEX)and introduction about their functions, missions and the company’s structure Inadditions, there are overview of risk management at COMA-IMEX in recent years

In chapter 2, the researchers present theoretical framework which issupported to the report This chapter covers key terms and definitions of riskmanagement, types and classification of risks, etc

Then, in chapter 3, by doing research of financial status and businessstatement of COMA-IMEX, the researchers gives comments on reality ofimport/export business at COMA-IMEX as well as COMA-IMEX’s achievementand failures

Finally, in chapter 4, the researchers makes some recommendations tostrengthen risk management at COMA-IMEX

1 Introduction of the research topic

In the speedy-growing economic world nowadays, it is essential that everycountry integrates in order to narrow the rich-poor gap between developed anddeveloping countries Pacific Asia, in the recent years, has been the most dynamicpart of the economic world Being a nation in this area, Vietnam is not out of thetrend One of the most important long-term strategies of Vietnam after joining WTO

is import-export promotion Through import-export business, Vietnam will be able

to bring the world domestic goods, to gain foreign currencies, as well as to createmore jobs, and to decrease the unemployment rate, etc It is undeniable that doingimport-export helps Vietnam speed up the economics improvement

In the course of conducting import and export business, payment transactionplays an extremely important role: it is essential for running the contract smoothly.The payment transaction holds direct influences on capital turnover, reproducingprocess, investment and profits of the company However, there are manydifficulties and complex problems which happen during the payment transaction,such as policy risk, exchange risk, credit risk, interest rate risk, etc These problemscan only be predicted and solved with professional experiences and good technicalskills

In particular, prevention of financial risks in business activities in generaland in international payment is an important task for all enterprises, includingCOMA-IMEX Therefore, “How to prevent financial risks in international paymenttransaction?” has become a question for managers That is the reason why I am

doing my research: “Risk management in the international payment at IMEX”

COMA-2 Purpose and scope of the research

The research has been carried out during my internship with helps frommanagers of COMA-IMEX and under the instruction of Mrs Nguyen Thi ThanhVan Due to the limit scope, the report mainly aims at:

 Analyzing general business as well as import/export business ofCOMA-IMEX from 2009-2011

 Researching and analyzing risk management methods that IMEX has been used so far

COMA- Suggesting some solution to improve efficiency of risk management

at COMA-IMEX

3 Research questions

There are 2 questions which the research deals with:

1 What is the reality of risk management in international payment atCOMA-IMEX in recent years?

2 How can COMA-IMEX improve the risk management in internationalpayment?

The research has been carried out using data from financial reports ofCOMA-IMEX from 2009 to 2011, course books about international payment,international trade and risk management from well-known scholars Observations aswell as interviews are important method which researchers use to work on thereport

CHAPTER 1 INTRODUCTION

1.1 An overview of COMA-IMEX

1.1.1 History and development of COMA-IMEX

COMA-IMEX is one of 29 members of Construction Machinery Corporationthat specializes in machinery trading, established by Decision no.1027/QD-BXD dated 07.26.2000 from the Minister of Construction The ConstructionMachinery Corporation is a state owned enterprise established in accordance withthe Decision No.993/BXD-TCLD dated November 20th 1995 issued by theMinister of Ministry of Construction, basing on the former Union of ConstructionMachinery Enterprise founded in 1975

The international name of the center is IMPORT EXPORT CENTRE,abbreviated as COMA-IMEX The centre has been registered with certification ofbusiness registration no 313597 from Hanoi Planning Committee on Sep 5th 2000.Currently, COMA-IMEX is located at 13th floor, COMA building, Lane HoaBinh 6, 125D Minh Khai, Hai Ba Trung district, Hanoi

1.1.2 Functions and missions

1.1.2.a COMA-IMEX’s functions

- Organize activities of sending Vietnamese experts and worker to work shortterm oversea with permission from Ministry of Construction

- Import goods such as: machines, raw materials… as the market demands

- Activities involves financial leasing

1.1.3 Organizational structure

There is a simple structure inside COMAIMEX with 29 personnel in total

-1 General Director, 2 Deputy Directors, functional departments with a manager and

a deputy manager of each department… as described below:

Chart 1 – Organizational Structure of COMA-IMEX

 The Board of Director including General Director and two Deputy

Directors are responsible for controlling and commanding all business activities ofCOMA-IMEX

 Accounting Department is responsible for staff salary payment and

other accounting activities; administrative business, receptions, monitoring andmaintaining working facilities are also included in their responsibilities

 Import/Export Sales Department advises and helps Director on

import/export business; does other works that involves import/export as required byDirector

 Labour Export Department advises and helps Director on labour

exporting by contracts

 Training Department is responsible for training and organizing

courses to provide employees with skills and knowledge before sending themabroad All other training-involved works are their responsibilities

 Labour Management Department assists Director in managing

labours working short term aboard, deals with other issues involving exportedemployees’ benefits and disputes during and after their working durations

 All departments and employees are expected to do other works as

General Director requires

1.2 Overview of risk management in international payment at IMEX

COMA-1.2.1 International payment reality in recent years

In recent years, the main goods to export at COMA-IMEX are small metallicdetails such as keys, door-hinges while main goods to import are heavy constructionmachineries of all kind Importing machinery is also main source of revenue atCOMA-IMEX in latest years, due to the high price of these kinds of goods (acontract to import one unit of construction machinery may reach the number ofUS100,100 in basis value, when COMA-IMEX sell the imported machine, profitmay be in range of 5% to 10% of the contract)

In 2009, revenue from sales of imported goods is 21,612,278,060VND whilerevenue from exporting is only 2,369,702,668VND, which takes only 9.88% of thetotal revenue (23,981,980,728VND) Revenue from importing is 10 times more thanexporting, which means in 2009, importing is COMA-IMEX’s key business

In 2010 and 2011, importing is still COMA-IMEX’s key revenue, but thedifference between import and export has been narrowed In 2010, revenue fromimporting is down to 15,791,573,880VND (71.73% of total revenue) but exportactivities brought COMA-IMEX 6,222,191,144VND (28.27%) which means nearly

as half as revenue from importing goods Last year (2011), both revenue fromimport and export increased rapidly which led the total revenue jumped up as twice

as in 2010 Export revenue in 2011 is about one third of revenue from importing

From the numbers above, researchers point out that COMA-IMEX’sfinancial condition is quite healthy, main business – importing – brings COMAgrowing and stable revenue However, COMA-IMEX is gradually improving itsfield of exporting, the unbalance between import and export is less and less, whichhave been proved in the year of 2010 In 2010, revenue from importing decreasesharply, if it was not for increasing revenue of export then COMA-IMEX cannotreached that high total revenue

1.2.2 Reality of risks at COMA-IMEX

1.2.2.a Some cases of risks which COMA-IMEX often faced

On Apr 4th 2009, COMA-IMEX signed a contract no 68/COMA/FOSHANwith trade company Foshan to import 5.000m2 of Double Low E tempered glassCIF at Haiphong port worth 845,000.00USD This contract was to serve the project

of Indoor Game Hall to celebrate 1000 years anniversary of Thang Long - Hanoi.Delivery time was within 120 days from the date of opening L/C On June 18th

2009, the Ministry of Construction declared Circular No 11/2009/TT-BXD on

"Regulation of the management quality of products, goods and construction glass."Among the content of regulations and circulars pointed out that:

"The importer must provide the customs authorities at the border gate all thecertificate of:

+ Assessing the control system of quality from manufacturer in accordancewith ISO 9001: 2008;

+ Assessing the quality of product samples, glass at the border gate buildingmust be in accordance with the quality standards setting out in this Circular;"

Indeed, circulars issued by the Ministry of Construction aims to buildtechnical barriers to trade (TBT) Like in other countries, there are three specificpurposes on this circular: to help protect production, protect consumers andpreserve the ecological environment in the country, and deal with the barriers of theother countries in international trade which are more and more modern andsophisticated (such as case of Thailand: Thailand launched the hygiene standards offood safety, regulation and registration of labeling foods for processed foods whichare very complex and caused foreign exporters a lot of time and cost; anotherexample is China where there are many strict regulations on hygiene and health atthe border and ports which create many difficulties to seafood exports)

However, the contract had signed before Circular No.11 /2009/TT-BXDpromulgated so COMA-IMEX not able to respond in time the seller's ship came toport In additions, FOSHAN is just a commercial company who is unable to definewhether their products meet the requirement as in ISO 9001:2008 or not

In the situation above, not only country risk that COMA-IMEX faced withbut also other commercial risk arises such as: delay in unloading goods, moreexpenses for storage fee, goods are unable to import so COMA-IMEX was unable

to deliver goods in time to provide the project of Indoor Game Hall

1.2.2.b Preventive solutions to risks which COMA-IMEX has used so farUsing the stable and strong currencies in international payment and usingforward contracts, futures contracts are some of preventive solutions to exchangerate risk which COMA-IMEX often used.

In order to prevent commercial risks, COMA-IMEX often in preference totrade with familiar, prestigious customers and partners than new ones Duringnegotiation about contract’s terms, COMA-IMEX always point out that the deliverytime is as soon as possible, it is often more than 3 months since the contract issigned

Nowadays, due to Government’s policy of foreign currency, getting foreigncurrencies to use in import/export business is a big problem to import/exportenterprises like COMA-IMEX To have stable sources of currencies, COMA-IMEXhas to buy from outside markets and re-sell to banks, or makes some agreementwith banks so that they can provide the company with USD or JPY in time

CHAPTER 2 THEORETICAL FRAMEWORK

2.1 Key terms and definitions

According to Dr Nguyen Van Tien (2011), Head of InternationalDepartment, Banking Academy, international payment is implementation of doingpayments and rights of monetary benefits which occurs through relationships ofconcerned banks, due to economic and non-economic activities, betweenorganizations and foreign organizations, or individuals and foreign individuals, orbetween a country and an international organization

2.1.2 Risks

Risk is threat of danger, damage, injury… which can be raised during manykind of actions in real life … In business life, breakdowns and accidents happen out

of a sudden may cause serious troubles and great loss of human or property All

of those unexpected incidents are called risks When talking about risks, it is often

about loss of physical assets caused by external or internal vulnerabilities

There are some preventive methods to deal with risks:

Avoid risks: which means do nothing risky or uncertain This method cannot

be used in business because avoiding risks equal to gaining nothing, no profit andbeing rejected in competition Since “high risk, high profit”, risks cannot be sweptout totally in doing business

Prevent and reduce risks: by using preventive methods to minimize risks

such as fire alarm systems, labour safety… and studying rules and regulations ineconomy, a company or manager will be able to reduce risks even though risks arenot disappear completely

Standby funds: spend a fixed amount of money to create a fund to use in case

risks happen Pros: companies will be self-prepared Cons: it is difficult to raiseenough money for the funds if a great risk happens; moreover, standby funds mayleads to dead capital

Risks transfer: organizations or individuals hire professional insurance

companies to be responsible for their risks

2.1.3 Risks in international payment

During the process of international payment, or in the process ofimport/export business, there are many chances that risks will happen There aremore than one ways to classify risks in international payment as well as ways todefine and evaluate them They can be classified by causes or by involved parties(when different methods of international payment are considered) In MultinationalBusiness Finance 10th Edition, risks are divided by range of influences:

(David K Eiteman, Arthur I Stonehill and Michael H Moffett, 2003)

In my report, risks will be divided by causes of risks into the two main types

of risks that import/export firms in Vietnam often faced with: Commercial Risk and

Risk in Payment (Financial risk)

2.2 Commercial risks

Definition of Commercial risk: “The risk that a debtor will be unable to pay

its debts because of business events, such as bankruptcy” (Campbell R Harvey,

Commercial risks in international payment are similar to risks occurs in domesticbusiness but more complicated and higher risky It can be considered differentlyfrom different sides of seller and buyers

In the lecture of “Risk management”, Võ Hữu Khánh, MA (2011) pointedout and classified commercial risks very clearly as below:

2.2.1 Risks to sellers

 Mistakes in payment

 Buyer’s poor finance or inability of paying

Buyers’ inability to pay within the agreed time, when their funds run out

of money, they may ask for extension of repayment

The payment may be compromised if the buyer can not improve theirfinancial situation immediately

The legislation: in cases that the buyers can no longer claim payment, that

enterprise shall be dissolved by law Exporter's debts are paid only after prioritydebts are settled such as debts of wages, debts of social organization, unpaid taxes There is very little chance for exporter to recover their money that buyer owedthem, even very small amounts Facing with the loss of the buyer's payment ability,there are few solutions unless sellers do effective measures of safety on paymentbefore making commercial contracts, or buy insurance from companies whoresponsible for this problem

2.2.2 Risks to buyers

2.2.2.1 There are risks to buyer when violations of contract happen such

as:

a Delay in shipment which affects business

Any delay caused by internal or external reasons such as delays inshipment caused by natural disasters or accidents, or changes in shipment orpayment terms, changes in transportations…will affect business badly

b Changes of payment terms

Lead to changes in plans and create difficulties (particularly in casebuyers pay with loans from banks) Sometimes, sellers unilaterally change the terms

of payment and force buyers to pay once for all before shipping

c Partial shipment

If not in special cases, partial shipment should not be allowed because thedrawback to this kind of shipment is its expense The cost for transporting a greatamount of goods always be more economic than several smaller packages

d Changes in prices

Higher prices compared to original prices in contract will lead to contractcancel or the buyers have to suffer a loss from the higher price In this case thebuyers may refuse to continue the contract and find another supplier but thissolution still makes delivery behindhand

e Risks in insurance

Lack of controlling may lead to serious breakdowns in shipment, in thatcase, even the money that insurance company pay to make up for goods has reachedthe highest level, it is still too low compared to real value of goods

f Quality of goods:

Any difference in quality of good compared to what has been signed indocuments will be considered inappropriate, which causes troubles to buyers inrelationships between the buyers and involved parties (such as authorities, customs,customers…)

g Origin of goods

Certificate of Origin is unchangeable, which means the origin of goodscannot be differ from one that signed in the contract

h Unhygienic state of goods:

In case the performance testing for safety and hygiene of goods does notmeet the medical requirement as in seller’s certificate, those goods cannot beimported

If the buyers import goods in order to sell to a third party, the contractbetween buyers and third party may be cancelled and buyers’ reputation will bedamaged

If the received quantity is bigger than one in contract, buyers have to paymore taxes and sometimes get trouble by being accused of tax evasion

2.2.2.2 Reasons for commercial risks

a Lack of information

Because of geographic distance between sellers and buyers, parties lack

of information about each other and cannot be sure about the ability of payment orprogress of contract performance

b Lack of knowledge

Trade laws are differ from country to country, all trade laws and UCP,Incoterms, ISBP… should be understood well in order to prevent commercial risksfrom happening

2.3 Risks in payment (financial risks)

Investopedia.com defines financial risk as “The risk that a company will nothave adequate cash flow to meet financial obligations” Another way ofunderstanding is that financial risk is any risk that comes from lending people orentity money or selling them goods without receiving money first… (FarlexFinancial Dictionary, 2011) In another words, financial risks are the probabilitythat an actual return on an investment will be lower than the expected return(businessdictionary.com) Financial risks also concern one company being unable topay off the debt to another company

Financial risks in international payment are economic risks happen during

international payment transactions, this is the reason why they are also called Risks

in Payment The reasons come from relationship between partners in the operation

such as sellers, buyers, banks… or other intermediary factors

Risks in payment include unpredictable incidents that affects both sellers andbuyers badly or even banks which provide international payment services toinvolved parties

2.3.1 Credit risk

2.3.1.1 Definition

According to Campbell R Harvey (2011), credit risk is the risk that an issuer

of debt securities or a borrower may default on its obligations, or that the paymentmay not be made on a negotiable instrument David L Scott explained in “WallStreet Words: An A to Z Guide to Investment Terms for Today's Investor” that

credit risk is the risk that a borrower will be unable to make payment of interest or

principal in a timely manner (2003)

Credit risks affect business results of the company badly When debts are notpaid partly or totally by scheduled, sellers will be in troubles, especially when creditrisks combine with exchange rate risk and risk of interest

2.3.1.2 Reasons for credit risk:

The competitive market nowadays is among external reasons for credit risk.

Price changes, outdated technology and equipment, financial crisis or globalregression… create domino effect which affects many companies with difficulties,losses or even bankruptcy

Internal reasons are lack of information and poor management and

administration skills If a seller or buyer does not have a thorough grasp of partner’sfinancial situation and ability of payment or does not know well about internationalpayment and the project they are doing, then credit risk is unable to be avoided

2.3.2 Country risk

2.3.2.1 Definition

Political situations and economic policies, foreign exchange managementpolicies of a country may change from time to time Those changes affect bothsellers and buyers; sometimes they prevent buyers from getting payment and sellersfrom getting delivery

General understanding of country risk is probability of loss due to economicand/or political instability in the buyer's country, resulting in an inability to pay forimports (businessdictionary.com) Below is another definition of country risk inFarlex Financial Dictionary (2011):

The risk that a foreign government will significantly alter its policies or otherregulations so that it negatively impacts the business climate in that country or thereturns on a particular industry, company, or project Macro-country risk deals withpolicy changes that harm, say, exporters or foreign-owned businesses in general,while micro-country risk implies that a government will deliberately target a

a country in which defense contractors operate may turn against one particularcompany because of its perceived excesses or against defense contractors ingeneral This may cause the government revoke contracts for one or more defensecontractors

Recession and currency crisis of a country or an area play an important role

to international payment of any import-export company They are unexpectedsituations which will lead to the reduction or loss of liquidity of the contracts signedearlier Besides, bank account embargo and blockade applied to accounts in foreignbanks make company’s international payment more difficult, delayed or even loseability to pay When there are country risks, there are often credit risks, interestrisks… go along with them and make them more serious

Country risks to buyers happen when buyers want to pay sellers butunexpected economic or politic incidents appear which make the buyers’Government forbid them to pay foreign currencies to foreign companies, orimported goods are listed as not subjected to customs clearance

Country risks to sellers happen when there are changes in policy of foreigntrade or customs in sellers’ country The sellers are ready to export but upheavalshappen such as tax for exporting increases or the to-be-exported goods areforbidden to export which make exportation postponed

2.3.2.2 Reasons for country risk:

 Conflicts of race, political parties, religion threaten the stability of a country

 Demonstrations, strikes, riots, wars

 The problem of foreign debt forces the importing government to use strongmeasures to forbid foreign payment or transfer foreign currency abroad

 Bad situations such as foreign currency reserves at a low level and thenational balance of international payments face the heavily deficit force theGovernment of the importing country to take action to stop foreign paymentsimmediately

 The economic international embargo on importing country puts allinternational activities and the Nostro accounts of the importing countriesunder strict control, or even be blocked so that banks cannot pay for foreigncountries

 Foreign exchange management policy of importing countries suddenlychanges, foreign exchange policy is tighten or forbidden in payment whichposes risks to importers and their banks

2.3.3 Legislative risk

2.3.3.1 Definition

Legislative risk is a risk occurs when there is a dispute or claim coming fromthe involved parties The issue raised is that which country's court is going to handlethe case and of which country will the law base on

Definition of legislative risk:

Risk that a change in legislation could have a major positive or negative effect on aninvestment For instance, a company that is a large exporter may be a beneficiary of a tradeagreement that lowers tariff barriers, and therefore may see its stock price rise On the otherhand, a company that is a major polluter may be harmed by laws that stiffen fines forpolluting the air or water, thereby making its share price fall

(John J Capela, Stephen Hartman, 2011)2.3.3.2 Reasons for legislative risk:

Since there are differences in legal environment and the laws between partiesand parties, no matter what international documentary credit selected which adjustspayment method selected (UCP-600 or not), in various countries this transactionwas also adjusted and dominated by legal system of the local country UCP and thelaws of the countries altogether create a legal framework for L/C transaction ofcommercial banks in general when participating in international payment However,the applying levels of each country are different up to the law of that country

Indeed, when there is a conflict between a term in L/C (no matter it followsUCP or not) and legal law of a country, the national legal law will be followed anddisclaim UCP Or another way of saying: the applying of UCP into L/C does notdeny legal law and cannot prevent the Court from applying national legal law(Dr.Nguyen Van Tien, 2010)

2.3.4 Foreign exchange risk

2.3.4.1 Definition

This type of risk often happens in L/C which requires fix kind of currency.When there is a change about exchange rate of that currency, sellers or buyers willget loss If the price of fixed currency increases then the buyers will suffer a loss,vice versa, the sellers will get loss Below is definition of foreign exchange risk,according to David L Scott (2003):

The risk that the exchange rate on a foreign currency will move against the positionheld by an investor such that the value of the investment is reduced For example, if

an investor residing in the United States purchases a bond denominated in Japaneseyen, a deterioration in the rate at which the yen exchanges for dollars will reduce

the investor's rate of return, since he or she must exchange the yen for dollars This

is also called exchange rate risk

2.3.4.2 Reasons for foreign exchange risk:

There are some factors that affect changes of exchange rates, which lead torisks of foreign exchange

 Status of the balance of international payments influences directly the supplyand demand for foreign currency, through direct effects on the exchange rate

 The purchasing power of the currency and the inflation rate in the concernedcountries

 The differences of interest rate between countries, between the domesticcurrency market and international currency market

 Some other factors such as political shock, social shock, impacts of naturaldisasters, war, psychological sensitivity

2.3.5 Interest rate risk

2.3.5.1 Definition

Definitions of interest rate risk are listed below:

Interest rate risk is “The chance that a security's value will change due to achange in interest rates.” (Campbell R Harvey, 2011)

The risk that interest rates will rise and reduce the market value of an investment.Long-term fixed-income securities, such as bonds and preferred stock, subject theirowners to the greatest amount of interest rate risk Short-term securities, such asTreasury bills, are influenced much less by interest rate movements Common stockprices are also affected by changes in interest rates, although the linkage is lessclear than is the case with debt securities and preferred stock

(David L Scott, 2003)The risk of loss due to a change in interest rates Interest rate risk is important totransactions like interest rate swaps In such a transaction, the party receiving thefloating rate will receive a smaller amount should the floating rate decrease.Interest rate risk is also important to bonds; if interest rates raise, the prices ofbonds fall This affects the secondary market for bonds; for example, if onepurchases a bond with a 3% interest rate and the prevailing rate rises to 5%, itbecomes difficult or impossible to resell the bond at a profit Finally, interest raterisk is important to project finance If interest rates rise, funding may not beavailable for a new loan for a project that has already started.z

(Farlex Financial Dictionary, 2011)