Political Risk and Money Market Instruments

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Date Submitted: 04/03/2010 04:22 PM

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Short paper #2: Money Market, International Trade and Political Risk

Investors in the money market along with other financial markets face some risks and one of these risks is the political risk. By definition, it is the probability that changes in government laws or regulations will result in a lower rate of return to the investor or, in the extreme case, a total loss of invested capital (Peter S. Rose, 2006). One of the areas where political risk is a serious issue is International trade; indeed, importer and exporter are usually a thousand miles away from each other but still, they want or have to open up to international trade. How can they possibly offset the effects of political risk and take advantage of their investments?

In the money market, market for short –term credit, many financial instruments are traded such as repurchase agreements, Treasury bills, commercial papers, bank certificates of deposit, and bankers’ acceptance. Each instrument presents a set of advantages for the investors. Also, due to globalization, the money market is not limited to the boundaries of a single nation. Investors from all over the world are taking part into the financial transactions.

But for an investor to take action, he has to make sure that his investment is conducted in a riskless environment or at least he will seek for the financial tools that can ease the risks of the investment. Unfortunately a lot of external factors can negatively affect an investment no matter how efficient the market is. Political risk (civil war, bad governance,…) is one of these factors. For example a U.S. exporter would seek to make sure that he will get paid after shipping goods to a relatively political unstable country.

So despite the unsecured environment some investors are living in, the financial system, say the money market, allows them to still be part of the worldwide financial transactions. This is not to argue that political risk does not affect the investments in a...