Investments in foreign markets are made to build wealth. As part of this process, investors must recognize the cultural nuances that separate foreign markets from their domestic base. From there, it is critical for you to understand how the mechanics of the foreign exchange market affect your bottom line. Lastly, recognize effective risk-management techniques to preserve global profits.
Foreign markets exist outside of your home nation’s political borders. Global markets introduce increased populations that can be targeted for higher sales and profits. Overseas markets also might offer a more accommodating sales environment because of fewer entrenched competitors.
Foreign markets can be categorized into developed and emerging markets. Industrialized nations, such as the United States, Germany and Japan, represent mature markets, with relatively stable political regimes and commercial environments. Emerging markets are identified by their higher profit potential and heightened risk levels. For example, Nigeria is an emerging market where portions of its abundant oil reserves are often shut out from the global economy because of rebel warfare.
Larger businesses gain entry into foreign markets by establishing overseas operations. Coca-Cola and McDonald’s are examples of multinational corporations that maintain formidable global presences. Multinational companies can thrive overseas by making small cultural adjustments to their current brand. For example, in the United States Nike focuses on football and basketball advertisements, but it often rolls out expansive soccer advertising campaigns in Europe.
Smaller investors can enter foreign markets through financial exchanges. These savers can buy shares of stock in multinational firms such as Coca-Cola, or can buy into global mutual fund shares for international exposure.
Foreign exchange facilitates global commerce. Foreign exchange describes the process of trading domestic currency for international banknotes to make and receive payments. Foreign exchange rates describe currency valuations, and they calculate the amount of one currency that is required to trade for one unit of a competing currency.
Consumers prefer higher exchange rates for domestic currency, which increases their buying power for foreign goods. However, businesses want lower domestic exchange rates. At that point, their exported wares become cheaper to overseas buyers, and profits denominated in foreign exchange translate into higher cash flow at home.
Advanced information technology and increasingly dependent commercial relationships exposes the global economy to contagion risks. "Contagion" describes the ability of one isolated economic event to make a transition to regional and worldwide financial panic. For example, Russian sovereign debt default would cause the Russian ruble to collapse. From there, all entities doing business within Russia would suffer large losses. These groups would then liquidate international assets to raise cash and finance themselves. The heavy sales activity would cause global asset values and stock markets to crash.
Global businesspeople can manage risks with diversification and derivatives. Financial diversification--by asset class, industry and geography--limits the impact that the failure of one profit source might have on your portfolio.
Sophisticated investors manage risks further with currency derivatives. Currency derivatives, such as futures, options and forwards, establish set exchange rates over certain time frames.