Statement of the Problem

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Statement of the Problem

By holding the debt market instruments, AIBF faces several risk exposures in the international business sense.  The first problem the AIBF faces is the foreign exchange risk exposure. This risk exposure comes in three basic forms. The first aspect is the transaction risk, which encompasses the risk of possible variation of value of the French currency that in turn would affect the value of the future cash flows that have already been committed. Due to the great uncertainties in the future of the European current situation, the transaction risk is a real risk that AIBF must be aware of and be prepared to deal with. The second aspect of the risk is the translation risk (or the accounting risk as it sometimes referred to). This risk is a problem that needs to be addressed by AIBF because it stands to cause a variation in the value of debt instruments that AIBF holds and which are denominated in the French currency; or in foreign currency in general. Lastly, a broader economic risk stands in the way of AIBF. This risk accounts for the impact that the variations on exchange rates are likely to affect the competitiveness of the AIBF in the Australian market.

This paper presents the risk management strategies in light of the above risk exposures and problems facing AIBF. While economic risks are general hard to manage, the paper attempts to formulate strategies that can be used to mitigate the other risks effectively in the short-term and presents situations under which the strategies are likely to work well. In light of the numerous hedging strategies available to manage the risk of exposure to foreign exchange risk, the paper argues that domestic currency invoicing is a good strategy that IABF should consider, besides the hedging instruments. This is in line with the views expressed by Döhring, who posits that domestic currency invoicing is a powerful tool that firms which deal in international market can use, while hedging instruments have become instrumental for firms to hedge against the risks that relate to exposure to foreign exchange rates (Döhring, 2008, P. 8).

Strategies to Manage the Problem

There are a number of strategies that AIBF can use to mitigate the risk of exposure to fluctuations of French currency. Given that the problem mainly lies with the debt finance instruments, and the risk involved is of short-term nature, one of the options of managing the risk of exposure to the AIBF is hedging. Given the situation, one of the forecasts that can be deduced from the situation is direction of fluctuation in the currency exchange rate for the French currency (Wei, 1999, p. 1378). Since it is more likely for the French currency to lose value hence the value of the held instruments, an appropriate hedging instrument should be used. Hedging is a good tool to deal with the short-term risk because there is a huge risk of uncertainties that would be involved in the long-term (Muller and Verschoor, 2006, p. 200). Therefore, hedging is an appropriate strategy and the AIBF should approach it as highlighted below.

Using Forward Contracts and Swaps

AIBF can use forward contracts to hedge against the possible exposure to the foreign exchange risk. A forward contract is a hedging instrument that sec.............