The Bank of Amsterdam is planning to diversify its investment in order to make money from the international capital market. The company is planning international capital market strategies aimed increasing the revenues of the bank. The company is planning to open a subsidiary in Croatia and this risk assessment will contain evaluation of the risks that faces the company in Croatia as it undertakes its operations. The evaluation will entails identifying the ranges of risks that the corporation is faced with in Croatia as it undertakes it operations, types of the risks, risks that can be retained and the ones that needs to be transferred through insured insurance in order to protect the company from related to occurrence of the risk in question. The assessment will also be concerned with determining risk management’s techniques that can be used by the firm to protect it against the risks. This investment analysis will involve identifying the advantages and disadvantages that the company will have by borrowing and lending money from two different countries and using the money for investment in a different country. The analysis will also involve making calculations on the gains that the company can make by using various hedging techniques as well as losses that may arises from using the hedging technique.
The bank will borrow 40 % of the initial capital from New Zealand and the rest from the domestic country from which it will invest the money. The company will open a subsidiary in Croatia where it will carry out its operations for the next 5 years. The subsidiary is expected to remit its revenue to the mother bank in Amsterdam each and every financial year. The company finance department can benefit from the international financial management strategy by borrowing and lending strategy as well as from hedging techniques. The company has to ensure that it gains from its remittance strategy by employing the best hedging technique given that capital market is faced with a lot of risks ranging from exchange rate risks and interest rate risk. The bank will use various derivative instruments to hedge itself against exchange rate risks and interest rate risk for the next five years within which it will be carrying its operations in Croatia.
The bank will borrow 2000000 New Zealand dollars as it initial capital and at the rate of 40 %.” In order for the bank to gain finically from the arrangement it will then lend the money at the rate of 45% to another company that is operating in South Africa. From this financial arrangement the bank will be able to gain a profit of around 5%. The other benefits from the investment will arise from using various risk hedging techniques to hedge the company against exchange rate risks.”.
Risks facing the Bank
There are a number of risks that faces each and every form of a business risks ranging from financial risks, pure risks, political risks among other forms of risks. Risk can be defined as occurrence of unexpected event that affects the earning capacity of a given firm positively or negatively. Amsterdam bank subsidiary branch which is involved in provision of financial services in Croatia, faces wide range of risks that needs to be identified and appropriate strategies employed to protect these risks from affecting the operations as well as the overall revenues of the firm.
After careful evaluation of both internal as well as external environment of the firm’s activities in Croatia, I come to the realization that the firm is faced with a wide range of risks. These risks include political, financial, pure and business risks. The detailed information regarding each and every risk will be analyzed individually to evaluate how the firm’s activities in Croatia are exposed to the given risk.
Political risks arises due to changes in governances structures that brings in new policies and rules to guide operations in a given country. Croatia has not been left out in introducing new rules and policies that directly affects the activities of Amsterdam Bank. The Croatian government has introduced new tax policies in the recent one year, where all multinational companies will be expected to pay taxes amounting to 35 percent of their gross income. As a result of the widespread strikes in the recent years the government has given a direction to all mining firms to provide enhanced terms of service to their employees and this new directive exposes the corporation to unexpected exposure. In line with the new directive the bank management will be forced to borrow a certain funds worth 10000 dollars from a local bank exposing the firm to interest risks that arises from this political risk.
The government will be using its central bank to come up with policies aimed at reducing inflation rate in the country as well as reevaluation of the country’s currency against other currencies. This has will result into the central bank increasing the interest rate for the last two years with an aim of reducing inflation rate in the country, by reducing the money in circulation. This government measures will expose the company to interest rate risks especially on Equipment loan that it had taken from a local bank amounting to 50000US dollars. Originally, the firm was hypothetical to repay the loan at an interest of 10 percent but due to interest rate variations for the last one year the firm is repaying the current loan balance at 14 percent.
Financial risks are risks that affect the financial position of the firm. The risks are of two natures, that is systematic and unsystematic financial risks. Systematic risks are those risks that cannot be controlled and they tend to be macro in character. The systematic risks that faces the bank in Croatia tends to be from external factors, that firm has no control over. These types of risks affect all firms’ activities in the same industry. In our case the systematic risks that the bank will be faced with as result of its operations in Croatia includes market risks, interest rate risks and inflationary risk.
The bank will also be faced with market risks that are as a result of changes in shares prices especially where the shares of the firm has been on the fall in the last one year. The company is faced with exchange rate risks due to fluctuations in exchange rate making the firm vulnerable to transaction risks, translation risks and economic exposure risks.
Risk Management and Derivative Instruments
Risk management is the process by which a company identifies ways that it can use to reduce the impact of a given risk on the operations of the company. There are a number of risk management methods that are available to any given organization. The risk management method largely depends on the nature of the risk and its impact on the firm in question.
Risk retention is one of the approaches that risk administration department needs to use in order to control the risks that the bank will be faced with. The risks that the corporation should retain are mainly those who arise from internal operations of the bank. The risks that the section can retain include those risks whose effect is not big to the activities of the bank.
Most of the risks that Amsterdam bank will be exposed to in Croatia need to be transferred to another party so that their impact can be reduced on the company operations. The firm management therefore, needs to be aware of the various insurance regulations in Croatia. The bank financial department can use hedging techniques such as swaps, option and future contracts to protect itself against exchange rate risks such as translation risks, economic risks and transaction risks.
Advantages and Disadvantages of the bank 5 years Investment strategy
There are a number of merits and demerits that the company will realize from investing in Croatia through using lending and borrowing strategy as well as hedging techniques. The first benefit that the bank will realize by going abroad will be the ability of the bank to access loans at a lower rate from international financial market. The bank will also be able to have access to international derivative market whereby it can gain from hedging against various forms of risks such as exchange rate risks and interest rate risk.
On the other hand, the bank operation in Croatia will be faced with a number of challenges which may have a negative impact on the earning capacity of the bank. First, the bank will be faced with exchange rate risks which may have a negative impact on the level of revenue that will be realized by the bank within the next five years. Fluctuations in exchange rate risks will expose the bank to currency risks where in most cases the bank will end up losing million of dollars due to these changes. The bank operations in the capital and money market will be largely affected by fluctuations in exchange rates resulting to the bank been exposed to interest rate risks.
Calculations relating to Possible Gains and Losses from the Operations of the Bank
Gains and Losses arising from Lending and Borrowing
In order for the bank to raise initial capital it will be expected to borrow 200000 New Zealand dollars at the rate of 40%. The bank will lend the same money to a different company at the rate of 45%.
Expected repayment at 40 %=140/100*200000= NZ $280000
Interest to be paid=NZ$80,000
Lending at 45%=145/100*200000=NZ$290000
Gain from lending=NZ$10,000
The current prevailing exchange rate in the market is 1 Croatian =0.21 New dollars.
From the lending and borrowing strategy that will be adopted by the company will enable the bank to gain 2100Croatian Kuna.
The curve below indicates the gain and losses made from the buying and borrowing arrangement made by the bank.
An option can be defined as the right to sell or buy an underlying asset at a specific within a given period of time (Durbin, 2011). The bank will get into a contract with various hedging companies and buy an option either inform of call or put option.
The company will be expected to buy the option at a premium. Any amount below or above the premium will be the gain or loss to the company.
For instance if the bank buys 20000 options at the rate of 2Croatian Kuna which at the premium of 0.5 Croatian Kuna; if the bank decides to exercise the contract and sell the options at 1.5 Croatian Kuna it will loss a lot of money from the contact.
Loss that will be realized from performing the contract;
1*20000=20000 Croatian Kuna
The above loss will be realized as result of the bank selling the options at a rate that is bellow the market price.
The bank can get into a contract with another bank where by it will get a fixed rate at which it will be exchanging its revenue to the domestic currency (Hull, 2011). For instance, if the bank approximates that it is going to realize a net profit of 400,000 Croatian Kuna. The exchange rate within the next one year will be 1 Croatian Kuna = US $0.5
The bank may decide to enter into a contract with another bank where it will exchange it currency at the rate of 1 Croatian Kuna = US $0.6 the bank will gain from the contract.
Gain to be realized from the future contract=0.6*400,000=US $240,000
Total gain=240000-200000=US$ 40,000
The bank may realize losses from its operations if the contract entered into has a rate that is below the prevailing exchange rate in the market.
The bank has the potential of realizing huge profits from its capital market operations. The operations of the bank oversees will be faced with political, business, economic exposure risks, exchange rate risks and interest rate risks. The company will gain from its technique of borrowing at a lower rate and lending the money to another company at a higher interest. Given the nature of the operations of the bank in Croatia within the next five years it will use derivative technique such as future contracts and options. In conclusion the bank should carry out the investment plan described in this analysis.