As the number of businesses participating in international markets grows, the threat of economic exposure grows as well. Economic exposure is the risk of doing business abroad. Some of the more common risks include a fluctuation of exchange rates, unstable governments and shaky economies. The possibility that foreign countries will not honor their debts is another factor. Another consideration is the increased expense of protecting the health and safety of employees. These factors have an effect on a company's cash flow and earnings, but the long-term earning potential from doing business abroad makes the risks acceptable to many businesses.
One example of economic exposure is if a company strikes a business deal with a small foreign nation and that nation becomes embroiled in a civil war. There is then a high probability that the country will not honor its debt obligation to the business. Depending on which side wins, the standing government might renege on the previous arrangement. On the other hand, even if the country does not change leadership hands, it might be burdened with the expense of restoring the country and therefore, the money to repay debts might not be available.
Companies who assume the risk of economic exposure hedge the risk with options for stock, currency or commodities. An option means the company has the right to buy or sell owned options or use them as leverage or protection. As leverage, the option allows the company to control its equity in the foreign deal. When used for protection, the option protects the company from market fluctuations. It also offsets losses from economic exposure. The value of the option is negotiated at the onset of conducting business with the foreign company or government.
When a company buys into an option, it usually does so for an amount equivalent to the original investment, and the option is for a set duration. If the company opts to not exercise its option right within the negotiated time frame, the option expires. An option is a right and not an automatic position that a company must take.
Most companies that choose to do business abroad are not there for the short term. These are long-term investments that the company anticipates will generate decent revenue in the future. A company looking for a quick turnaround investment might be better served investing in its home country. The inherent risk of economic exposure could be too great for a quick turnaround.
