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BBA - Organisational behaviour. BBA - Business Forecasting. BBA - Strategic Management. CHN - Contemporary China. In this hypothetical case, a mere 5 percent drop in the dollar would deflate the cash margin to 11 percent. At unchanged US dollar prices and volumes. Note that the pure portfolio risk only decreases cash flow by an additional 5 percent, which equals the difference between the cash-flow decrease in dollars 28 percent and euros 32 percent. For our German brewer, for example, a 17 percent drop in the dollar would turn cash flows from US operations negative.
Which currency risks can be managed?
Of course, inflation could bring prices in the United States and Germany back in line with the exchange rates between the dollar and the euro, but this could take several years. Empirical research indicates that deviations in purchasing power tend to be reduced by 50 percent over an average of two to three years; see Alan M. Taylor and Mark P. Because they are rooted in a fundamental mismatch in cash flows, structural risks are also the most difficult to manage. Sometimes, structural risks are more subtle. For example, our German brewer would have far more limited US dollar exposure if all its competitors in the United States would be producing in the eurozone as well.
Alternatively, it could be exposed to currency risk even if it sold only in the eurozone but with UK competitors producing in British pounds. The German brewing company exporting to the United States cannot use financial instruments to hedge the structural risk because of the size and duration of the exposure it would require hedging the full amount of dollar-denominated revenues for all future years in business. The only effective way to reduce structural exposure is to reduce the underlying mismatch of cash flows. For example, automobile manufacturers from Germany and Japan having shifted production to the United States, thereby lowering their structural exposure to the dollar.
Similarly, arranging local funding of foreign operations will mitigate structural exposure although the impact is usually limited, as financial expenses tend to be a small fraction of the total cost base. The German brewer can only sell its beer as a premium import in the US market if it is brewed in Germany. As the most visible currency risks a company faces, transaction risks are also the simplest to measure and manage. These occur as a result of timing differences between a contractual commitment and actual cash flows.
Suppose a company manufactures a product in China and sells it in the United States for a price set in dollars. Note that purchasing-power parity does not help in reducing transaction risk: Transaction risks typically affect short-term cash flows and are unlikely to put a company into financial difficulties except for extreme cases—for example, when it commits to very large purchases or sales that are fixed in a foreign currency.
Managing transaction risk is relatively straight-forward with financial instruments because each transaction is clearly definable and mostly short term. Many companies have hedging programs for their operating cash flows from foreign operations. Companies may have good reasons for managing currency risk—for example, to facilitate planning and performance management or for tax purposes. In general, they should not manage currency risk just for the sake of lowering cash-flow volatility or boosting share price. Shareholders are well aware of the currency risks faced by the companies they invest in and can manage any associated volatility themselves by appropriately diversifying their investment portfolio.
Furthermore, in the long term, currency fluctuations tend to be offset by price changes, thereby reducing currency risk in real terms. As academic research shows, investors therefore do not require a risk premium for bearing currency risk, and companies with lower currency risk will not experience a lower cost of capital.
See, for example, Piet Sercu, chapter 19, in International Finance: Theory into Practice , first edition, Princeton, NJ: Princeton University Press, Instead, managers should focus on those currency risks that could lead to financial disruption or distress. Deciding how much currency risk is acceptable should be similar to deciding how much debt is acceptable: That risk appetite could be expressed as a target default probability, cash flow at risk, or simply a target coverage ratio or credit rating.
Given the target, managers should identify which currency risks are acceptable and which are not. The recipient government will redirect its resources to areas it deems a priority that cannot be funded externally, for example the military or prestige projects. States have several tools they can use to further their foreign policy. Chief among these options are diplomacy, cooperation and association agreements, trade, economic sanctions, military force, and the use of foreign aid.
Foreign aid, then, is one of a number of tools that policymakers can use to further their foreign policy goals. Foreign aid also allows the donor state access and influence in the domestic and foreign affairs of other states Apodaca, Tarnoff and Lawson report that U. Foreign aid is an expedient tool for the diplomat. It helps governments achieve mutual cooperation on a wide range of issues. The objective of foreign policy is to influence foreign governments and shape international affairs to suit the state.
Generally speaking, states have two overarching goals in their dealings with other states in the international system: As a tool of foreign policy, foreign aid is provided to a recipient country as either a reward for some behavior or as an inducement to change behavior. Indeed, all foreign aid comes with strings attached, 1 a fact U. Decisions on how, where, and when to allocate foreign aid is made by political leaders in the donor country. Consequently, foreign aid is used as a means of pursuing foreign policy objectives. Foreign aid can also be used to complement to military intervention.
During and after an intervention, foreign aid to the target state increases significantly.
Foreign aid is a tool used to supplement the use of military force to ensure that foreign policy goals are met and, once met, secured. The goals of encouraging good governance and democracy, fostering human rights standards, or alleviating poverty in the target state cannot be achieved with military might alone.
They often require the provision of foreign aid. Academic researchers have studied foreign aid since the establishment of aid giving. Researchers are perplexed as to why and under what circumstances the leaders of one state would provide valuable resources to another state. The continued and increased flow of foreign aid to underdeveloped states is all the more puzzling since because studies have shown that the official reason for aid allocation, economic development, has proven elusive.
Is it due to the channels of aid disbursement?
Foreign Aid as Foreign Policy Tool
Or perhaps it is about the fungibility of aid itself. The following sections cover several aspects of the relationship between foreign aid and foreign policy, beginning with a general discussion of what political leaders and researchers include as foreign and followed by discussions of the allocation of foreign aid, channels of foreign aid disbursement. The resources can be economic in nature, such as financial contributions, but can also include technical assistance and commodities such as food aid or agricultural equipment.
The costs of humanitarian aid within peacekeeping operations can also be considered foreign assistance. Several states include the gift or sale at concessional rates of military equipment as foreign aid, but the OECD specifically states that official development assistance ODA should not include military aid or antiterrorism activities. Social Infrastructure and Services, including funding for education, health, and the promotion of civil society.
Economic Infrastructure, which funds projects for transportation, energy, communications, and banking and financial services development, Production Sectors, which include funding for agriculture, forestry and fishing, industry, mining and construction. General Budget Support funds, which are contributions to government budgets and support for macroeconomic reforms. Humanitarian Assistance, which encompasses emergency response, reconstruction and disaster prevention, and constitutes Humanitarian Assistance funds are donated to assist in man-made or natural disasters.
Multisector Support funding, which is geared to projects which straddle several sectors but basically include the environment and biodiversity. Multisector support is a recent category of aid and accounted for Action Relating to Debt, which includes debt swaps, debt forgiveness, and debt relief. The remainder is unspecified aid. While aid aimed at economic infrastructure is usually targeted at countries with good governance and mature economic institutions, countries that lack such capacities usually receive aid in the form of social-sector assistance.
Social-sector aid allows donors to target the welfare of the people, generally channeling aid through NGOs or multilateral organizations in ways that avoid bad policies of or corruption in recipient governments. Government involvement in education and health is less mandatory than government involvement in trade policy because substitutes for government institutions and procedures may be found in civil society or provided by NGOs and multilateral aid organizations Bermeo, Aid directed at general budget funds, meanwhile, is given with the implicit understanding that governments can use these funds as they see fit.
Donors become less reliant on good government policies as they move away from economic infrastructure and general budget support to production sector funding, to humanitarian assistance and the social infrastructure sector Bermeo, Similarly, Akramov finds that aid directed at the production sector can be effective at promoting growth even in bad policy environments. Economic infrastructure aid, however, is effective only in countries with medium to high governance ratings.
Donors vary the sectorial composition of their aid in response to perceived governmental quality. Countries that are well-governed receive greater shares of their ODA in the budget, economic, and production sectors. Official governmental rhetoric declares that development and poverty reduction are principal reasons for granting foreign assistance.
Foreign aid is given to a recipient country to facilitate economic development, alleviate poverty, and improve human welfare. Aid contributes to global security by tackling threats to human security, such as human rights violations, disease, population growth, environmental degradation, peacemaking, and the growing gap between the rich and the poor. Poverty and extreme inequalities are often causes of social instability and civil unrest, which, in turn, can produce flows of refugees and acts of terrorism. Thus, aid helps build a safer, more peaceful, and more secure world. Foreign aid is provided to many countries but is concentrated in countries reflecting the priorities of the international community and individual donor states.
Lumsdaine , for example, found that humanitarian concerns and moral values were a primary motivation in the allocation of multilateral foreign aid. Lancaster argues that the provision of foreign aid has developed into an international norm. Rich countries provide assistance to poor countries to better the human condition. States are subject to the norms of behavior established by the international community. The allocation of foreign aid has become an accepted and expected standard of behavior among developed states, a standard that is now being recognized among a greater number of middle-income states.
Most developed states have established foreign aid agencies, instituted foreign aid mandates, processes and procedures, and joined the DAC. Donor states provide foreign aid to alleviate poverty and foster development in the neediest underdeveloped countries. Lancaster admits, however, that given the number of potential recipients and the ever-expanding need due to disasters, poverty, or economic crises , donors can also use their aid as incentives or as payments for approved behaviors, or to signal a desire to expand political relationships between donors and recipients.
Consequently, researchers have determined that foreign aid is often provided for interests other than developmental or humanitarian reasons. However, the EU countries do not wish to optimize their foreign aid because they have economic and political purposes other than poverty reduction when they allocate aid. Foreign aid is used predominantly to promote geostrategic interests, for the right to build and maintain foreign bases, to strengthen alliances, or to keep allied regimes in power.
Foreign aid is also used to maintain friendly relations with foreign governments. Foreign aid facilitates cooperation, and it builds strong alliances. First, foreign aid can be used to maintain nations as allies. Second, foreign assistance may be granted in an attempt to gain foreign allies. And third, foreign aid can be used to win the hearts and minds of a population. For example, foreign assistance is viewed as an important instrument in the prevention of terrorist attacks by reducing the appeal of terrorist ideology.
There is a general belief that foreign aid could reduce the likelihood of terrorist attacks by averting the causes of terrorism—namely, hopelessness and resentment as the result of extreme poverty, illiteracy, and hunger. Foreign aid would also be used to reduce poverty and inequality in the recipient state, thought to be a source of terrorist activity Bush, Helping the poor increase their standard of living would also ensure that they would not fall prey to the ideological underpinnings of fundamentalists. Del Biondo concludes that the EU has moved closer to the United States in that its foreign assistance is more explicitly focused on security matters.
Providing aid for antiterrorist programs, along with economic growth and development, as well as poverty reduction schemes in developing countries, safeguards European security. Getting rid of poverty will make for a better world for everybody.
International Trade Law Assignment WTO | BTX - International Trade Law | Thinkswap
Thus, foreign aid is always in the service of foreign policy. Geopolitical motives for foreign aid allocation have evolved over time and, in turn, affected the levels and direction of aid flows. During the Cold War, foreign aid was a tool Western states used to contain the spread of communism and to keep the power of the Soviet Union in check.
Security concerns have, and will continue to have, a significant influence on the allocation of aid. Giving aid for geopolitically motivations aid is not an efficient use of aid, however, if purpose of the aid is poverty alleviation in the recipient country. But foreign aid can be successfully used to buy strategic concessions, such as the building of military bases or consolidating military alliances from the recipient government.
Foreign aid can be a large component of foreign capital flows for many low-income countries, thus increasing their dependence on donor governments.
Foreign Exchange
Foreign aid can also be used to further the economic interests of the donor state. Recipient countries that provide a favorable climate for foreign investment and trade receive more assistance. Also, the giving of aid can secure access to vital raw materials oil, minerals, etc.
The commercial motive of foreign aid can be seen in the practice of tying aid. Tied aid is when a country binds its aid to the procurement of goods and services from the donor country. Tying aid is a common practice among donor nations. In contrast, Norway, Ireland, and the United Kingdom do not tie their aid.
Tying aid can reduce the value of the aid because it prevents the recipient country from buying the best-quality commodities at the lowest prices. France, Portugal, Spain, and the United Kingdom are substantial donors of foreign assistance to their former colonies. Aid by ex-colonial powers can help continue or regenerate colonial spheres of influence and reinforce political alliances.
The aid provided by France is often cited as an example of a former colonial power wishing to maintain the special relationship with its ex-colonies.
Decide which currency risks to manage
Aid provided by the French is used to fund educational training in the French language and culture. Aid can be given to prevent or offset the effects of global negative externalities that can potentially affect the developed countries such as infectious diseases, environmental contamination, or debt default. And providing aid to countries neighboring a conflict or disaster can stem the flow of refugees seeking asylum in the West. States adopt an identity and role in the international community, and some states choose to be viewed as generous global citizens.
If aid were solely motivated by foreign policy objectives and donor self-interest, then how the recipient uses the aid and the importance of the quality of governance in the recipient country should not matter. However, Kilby and Dreher show that in practice, states use foreign aid to achieve many overlapping foreign policy goals, including fighting terrorist threats, supporting strategically important countries, fostering relations with countries that maintain large bilateral trade or capital flows, and the championing humanitarian goals of reducing poverty, encouraging democracy, enhancing gender status, and improving human welfare.
When pursuing foreign policy, including foreign aid policy, states can choose between bilateral or multilateral actions. Bilateral aid is resources that flow directly from one country to another. Bilateral aid can be delivered through the public sector, NGOs, or public-private partnerships with the recipient country. Those who advocate the use of foreign aid as a geopolitical foreign policy tool prefer bilateral foreign aid because of the strategic objectives to be gained. With bilateral aid, the donor retains control over the funds and determines who will be favored with aid and under what conditions.
Most foreign aid is overseen, and frequently managed, by the donor Riddell, Donors do not like to give up control of their aid 4 by channeling it through a multilateral agency, unless, of course, they have significant influence over the decision-making operations of the agency. The receipt of bilateral foreign assistance leaves the recipient obligated to the donor. Multilateral aid can only be delivered through the multilateral organization. Headey suggests that donors tend to channel their anti-poverty, development motivated assistance through multilateral institutions and use their bilateral aid to pursue geopolitical objectives.
Earmarking allows the donor and likeminded countries greater influence in the allocation of multilateral aid decisions by targeting priority issues or economically and politically important countries. The ability to use the multilateral institutions while maintaining control of their foreign aid is a widespread donor strategy.