Running head: CAPITALIZATION RISKS 1

Transcription

1 Running head: CAPITALIZATION RISKS 1 Challenges and risks of running a large Multi-national Financial Institutions such as Banks and Insurance Company Student s Name Institutions and Affiliation

2 CAPITALIZATION RISKS 2 Capitalization Risks Most Multinational companies can be defined by the level of capital structure they are adopting in their daily transactions so as to meet their financial needs. It might take the form of debt or equity and can be adopted either in the long term or in the short run. However, during the adoption or implementation, the multinational banks or insurance company normally face a number of risks or challenges which influence their operation and the amount of debt or equity to adopt. These risks include geopolitical risks, currency risks, market security risks and management risks (McCarthy, et.al, 2001). Management Risks In financial management, there are a number of risks which is associated with the adoption of the capital structure of an organization. The multinational Institution such as banks and insurance companies are sometimes full of ineffective, underperforming management personnel hence hurting the companies' financial health. It normally happens when the management put their interest first as oppose to the interest of the shareholders. The case was witnessed in various banks and insurance firms which lead them to receivership, destroying the shareholder's wealth instead of maximizing it. Besides, the company will also have a bad reputation which can lead to liquidation of the company in the long run. Currency Risks Given that the multinational banks and insurance company operates in the global market, they are prone to the currency risks.it is the risks that arises as a result of changes in the prices of one currency about another. The risks may cause or create unpredictable profits and losses to the company. The main type of currency risks faced by these companies includes transactional risks

3 CAPITALIZATION RISKS 3 and translation risks (Van, 2013).They are very detrimental to the megaprojects since they are predominantly significant and often damage a very large and rarity investment projects (McCarthy, et.al, 2001). It is the reason why when companies face these types of risks; its financial structure tends to be compost of huge debts as compared to equity. These risks can just be mitigated by hedging which helps to offset the currency fluctuations. Geo-Political Risks Politics also plays a vital role in determining the capital structure of an organization. In the case of multinational companies, risks can be described to mean the political decision which is made by the host country and it tend to have adverse effects on their profits or the entire objectives and goals. Some of these risks can prove to be detrimental such as revolution which results in widespread destructions and creation of rules and regulations that prevent mobility of capital and assets from one country to another. Besides, these risks can also be classified as micro and macro risks. Micro risks are those risks which affect certain industrial sectors, and they include corruption and prejudicial actions which are against the companies actions especially from foreign countries. Besides, macro-political risks refer to the adverse actions that affect all the foreign banks and insurance company in the market (McCarthy, et.al, 2001). These factors affect the banks and make them lose a lot of money especially if they are unprepared for the unforeseen occurrences. These risks thus can be mitigated by taking political insurance cover which protects the company from losses arising from such risks.

4 CAPITALIZATION RISKS 4 Market Security Risk The market risks are risks which are commonly inherent in the entire market segment especially in the stock market. During the times or recession, every investor who put their resources in the stock market can lead to adverse economic effects in the market. It affects all the investors regardless of different asset classes in a variety of ways. However, in the case where an investor holds a larger base of stocks and bonds, they tend to be impacted less than those that hold stock. These classes of risks affect how the company operates and the objectives they set so as to maximize their returns and optimize the shareholder's wealth. The main types of risks which can be faced in the market include interest rates risks and inflation rate risks. Besides these mentioned risks, multinational banks and companies also face ideal risks and challenges as a result of the BREXIT, which i a process used to describe the European exit from the European Union. The process did posit great changes in the economic and political aspect of the operation. For instance, the British experience a shock which led to a depreciation of pounds, a drop in the credit ratings from AAA, which means that the cost of government borrowing will incline hence affecting the operations of various investors in the country (Liddle, 2015). Besides, the exit is forecasted by the world banks to reduce the world s economic growth by 0.1% following a greater decline in the UK s economic growth. It is because; the multinational companies will not be allowed to trade freely in the Eurozone since they are exposed to trade restrictions such as quotas, tariffs, and duties (Liddle, 2015).They will be subjected to various tax brackets which will affect the normal operations of the firms and other multinational companies. In order to protect these companies from these adverse effects, the United Kingdom government will be forced to contribute to the European Union Budget so as to remain in the European Trade Area. It can thus be predicted that the government will remain

5 CAPITALIZATION RISKS 5 with less money to spend as oppose to when they are members of the European Union. Besides, the multinational companies will also be exposed to different risks which affect the capital and labour flow hence inefficiency. Considering the changes in the political and economic aspects existing in the market individuals as well as firms should devise a mechanism and makes the right choice when it comes to investment choices so as to mitigate and overcome these risks Ways in which one can invest internationally through multinational companies In the past, it was not very easy for the company to invest in the foreign and international markets. However, due to globalization and advancement in knowledge and technical know-how, the emergence of mutual funds, exchange traded funds, American depository receipts, and multinational companies operations. These methods help the US firms to climb the hurdles which arise due to regulations and taxes. However, there are a number of risks associated with these types of investments. For instance, the international companies cannot provide the same diversifications as funds, and the mutual funds possess high expense ratios hence most investors will prefer to choose the domestic option as the best strategy (Fund, 2015). Besides, ADRs has various impacts on the decision made by the European Union on companies especially those in the IT sectors as far as tax, cash and cash equivalents are concerned. This option of investment exposes companies to foreign exchange risks especially during the payment of cash dividend which are valued in another currency apart from the US dollars. Besides, they also face the selection or choice problems, illiquidity especially when the companies are not willing to hold the investments for a long period of time. Besides, the company also faces diversification risks and withholding and other taxes attached to such investments. These taxes are attached to the dividend paid on such investments to different shareholders who have a stake in such companies.a good example is Enno and Apple. The ADRs also attracts the 1.5% of the stamp

6 CAPITALIZATION RISKS 6 duty reserve tax hence imposes a lot of expenses on the investors as well as the companies while operating by the use of this method of international trading system. It can thus be concluded that capital structure of a firm decision is crucial for the growth and development of a company. While making such decisions on which type of capital to use the risks associated with its adoption and management should be taken into consideration and appropriate mitigation strategies to be developed so as to ensure that the set objectives are met. These risks may include the currency risks, political risks, and market insurance risks. Besides, due to the exit of United Kingdom from the European Union imposes political, currency as well as economic impacts on the trading system in the entire system. Therefore, the multi-national company should be in a position to develop divergent strategies which they can use to mitigate these risks so as to optimize the profits.

7 CAPITALIZATION RISKS 7 References Fund, I. M. (2012). Turkey. Washington: International Monetary Fund. Fund, I. M. (2015). Luxembourg. Washington: International Monetary Fund. Liddle, R. (2015). The risk of BREXIT: Britain and Europe in Liddle, R. (2015). The risk of brexit: The politics of a referendum. McCarthy, M. P., Campbell, S., & Brownstein, R. (2001). Security transformation: Digital defense strategies to protect your company's reputation and market share. New York: McGraw-Hill. Van, B. J. (2013). Wiley Series 6 exam review test bank: The Investment Company Products/Variable Contracts Limited Representative examination.