Currency Crisis – The Strategies to Mitigate its Impact on Investors

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Student Name: Moath Assad Srour  

ID: 11088

Currency crises played a huge role in the economic disturbance of the interwar. Currency crisis is a type of financial crisis that occurs when there is decline in the value of a country's currency. This kind of decline in the currency impacts the economy severely and brings it to the downward trend and creates instability in the exchange rates. Due to this, the value of currency in the international market decreases drastically. One of the methods of minimizing the impact of currency crisis is by pooling adequate foreign reserves.

The world witnesses many instances of currency crisis till now. One of the recent crisis was during 1990s. The European Monetary System started experiencing a huge offloading of assets by the investors. The reason attributed to this was the disturbances in the exchange rate mechanism. Soon after this crisis followed the crisis in Asia and Mexico. It was thought that the crisis would spread to other parts of the world and would negatively impact their monetary systems. Researchers and Analysts generally do not provide any single acceptable reason as to why currency crisis would occur in some countries. Traditional models attribute currency crises to a deterioration of economic fundamentals. On the contrary, the recent models hypothesize that such crises may be as a result of the self-fulfilling prophecies or the shock effect that spreads over many countries. The different perspectives of the various models on what causes a currency crisis makes the study an interesting one and needs further investigation.

It is very important to understand currency crisis and develop mechanism to minimize its impact. One of the most important mechanism to minimize its impact is to analyze the degree of risk tolerance of investors. Past experience shows that before the financial crisis, most of the shareholders enjoyed several years of relatively good returns with little volatility. They became comfortable with the market's risk and reward proposition as long as it heavily favored rewards. As markets began to drop, many shareholders who thought they were comfortable with their risk tolerance, overestimated the risk and they left the market. Risk tolerance is unique to each shareholder. Some shareholders are more comfortable with market volatility than others.

The second strategy is to maintain a cash reserve. This strategy focuses on the need to balance both flexibility and discipline in responding to sudden events like currency crisis. This can be achieved by maintaining reasonable levels of cash reserves within an investor's overall investment and funding plans. The third strategy is to develop and inculcate good financial habits by the investor. It is important for the shareholders to realize several behavioral and environmental factors which can either assist or prevent the achievement of their targets. The shareholders should use the past lessons to build excellent financial habits which help in minimizing the stormy financial periods like currency crisis. The other strategies which can be used are Weigh Fundamentals versus Feelings and using the debt strategically.

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