There are also non-qualitative, or financial risks, associated with foreign currency loans. Namely, because foreign currencies can be effected by such uncontrollable as political, governmental and natural factors, a foreign currency can suddenly change in a manner that either significantly benefits or disadvantages the borrower. For example, often time the rate of a foreign currency is based on such things as internal, regional or international political conditions. If a particular country has a significant political upheaval, the instability associated with such an event can have a negative impact on a nation's economy, which of course effects the foreign currency exchange rate and, thus, the borrowers investment. When such an event happens to a nation with a dominant currency, this change can have devastating effects on a loan, as was the case following the September 11, 2001 terrorist attacks on the United States.
Another means to reduce risk is to use hedging techniques. A hedge is essentially an investment that is taken out for the specific purpose of reducing or canceling the risk associated with another investment while still allowing the borrower to profit from his or her...
As applied to foreign currencies, hedging can be accomplished in two primary ways: through standardized contracts or with customized contracts. With either strategy, the result intended is to eliminate currency risk by transferring the currency risk to someone else who does want a position in the currency. In exchange for the taking on of this risk, the hedge fund, or borrower, essentially pays the other investor to take on the currency exposure.
In conclusion, like any form of investment activity, the use of foreign exchange loans always present a risk to the borrower. However, if the borrower is careful as to monitoring and evaluating changes in the market, or goes through a managed foreign currency loan, many of these risks can be reduced, if not eliminated. The result of reducing any associated risk is that the borrower has an opportunity to actually make money on borrowed loans.
Bibliography
Almekinders, Geert J. (1995): Foreign Exchange Intervention: Theory and Evidence. New York: Edward Elgar Publishing, Inc.
Eijffinger, Sylvester. Foreign Exchange Intervention: Objectives and Effectiveness. New York: Edward Elgar Publishing, Inc.
