Investing in Currencies That Are on the Corner

 Country Risk refers to the possibility of lending or investing in a particular country, stemming from possible fluctuations in the domestic business environment which can either favorably or otherwise affect the value of investments in that country. For example, there might be a downtrend in China's growth, but in that country, another country that has previously been a main trading partner (in the past), could experience a rapid rise in its economy. The implication is that when investing in one country, one should be prepared to lose it (and possibly gain in other countries) simultaneously. However, there are various methods to hedge against such eventualities and hence avoid any eventual losses. One such method is through "sterilized asset protection" whereby certain financial instruments (like bank deposits, bonds, shares etc) are protected from fluctuations in the stock markets by a country's central bank.

Another example of country risk refers to political risk. Political risk can be either a short term (i.e. current) or long term (i.e.

Political risk can either be short term or long term. When discussing this issue, some investors tend to use both terms interchangeably. However, they are referring to two very different things. Political risk can refer to the potential dangers for an investor in a specific country arising out of the country's relationship with other investors. It can also be considered a credit risk, where the potential losses stem from the inability of an investor to service (and repay) credit due to excessive reliance on external financing sources.

Political risks have been highlighted as being an important contributor to poor international performance and low economic growth. In fact, political risks are one of the major drivers of the country risk premium, which is essentially the cost of insuring an asset in a country that may not be stable or which may experience severe economic turmoil in the future. Simply put, if you purchase stock in a country that is on the brink of a financial crisis, your investment is at very high risk. Even though you may have originally purchased shares at a price which has subsequently dropped, you may still incur large losses. There are a number of strategies that investors can employ to minimize their exposure to political risks, such as diversifying their investments across different currencies.

Country risk can also be exacerbated by changes in credit ratings. In the past, credit ratings have typically been based on Moody's or Standard. Over time, the change in the rating system brought about changes in Moody's and Standard's credit ratings. Now, the credit ratings reflect more on external variables than on characteristics of the country in which the companies have their operations. As such, if the credit rating agency downgrades in the credit ratings of a particular country in order to pressure the government to enact policy that is beneficial to its investors, this would likely have a negative impact on the foreign portfolio investments.

The combination of these two risks is referred to as countercyclical investing. In the past, this form of investing has been reserved for countries with stable GDP growth rates and low inflation. However, because of the fluctuations in currency values, many investors have become concerned that they may be exposed to a sudden financial crisis. As a result, they have started exploring methods of hedging against this type of market risk by investing in products like forex and bonds. While these methods do not completely eliminate the country risk associated with the currency markets, they do reduce it significantly and coupled with sound financial strategies, can help investors reduce their risk in these markets.