1. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. International Financial Management Abridged 10 th Edition by Jeff Madura 1

2. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2 16 Country Risk Analysis Chapter Objectives This chapter will: A.Identify the common factors used by MNCs to measure country risk B.Explain the techniques used to measure country risk C. Explain how to derive an overall measure of country risk D.Explain how MNCs use the assessment of country risk when making financial decisions E. Explain how MNCs prevent host government takeovers 2

3. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3 Why Country Risk Analysis Is Important 1.Country risk is the potentially adverse impact of a country’s environment on an MNC’s cash flows. 2.Country risk analysis can be used to monitor countries where the MNC is currently doing business 3.MNC can use country risk analysis to revise its investment or financing decisions in light of events such as: a.Terrorist attack b.Major labor strike in an industry c.Political crisis due to a scandal d.Concern about a country’s banking system e.Imposition of trade restrictions on imports

4. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4 Country Risk Factors: Political Risk 1.Attitude of consumers in the host country 2.Actions of the host government 3.Blockage of fund transfers 4.Currency inconvertibility 5.War 6.Inefficient bureaucracy 7.Corruption

5. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5 Country Risk Factors: Financial Risk Economic Growth influenced by: 1.Interest rates: higher interest rates tend to slow growth and reduce demand for MNC products 2.Exchange rates: strong currency may reduce demand for the country’s exports, increase volume of imports, and reduce production and national income. 3.Inflation: inflation can affect consumers’ purchasing power and their demand for MNC goods.

6. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 6 Assessment of Risk Factors 1.Macroassessment of country risk: overall risk assessment of a country 2.Microassessment of country risk: assessment of a country as it relates to the MNC’s type of business.

7. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 7 Techniques to Assess Country Risk 1.Checklist approach: ratings assigned to various factors 2.Delphi technique: collection of independent opinions without group discussion 3.Quantitative analysis: use of models such as regression analysis 4.Inspection visits: Meetings with government officials, business executives, and consumers to clarify risk. 5.Combination of techniques: many MNCs have no formal method but use a combination of methods.

8. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 8 Measuring Country Risk 1.Variation in methods of measuring country risk 2.Comparing risk ratings among countries a.Use of foreign investment risk matrix (FIRM) 3.Actual country risk ratings across countries a.Many countries experienced a deline in country risk ratings due to the credit crisis.

9. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 9 Exhibit 16.2 Determining the Overall Country Risk Rating 9

10. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10 Incorporating Risk in Capital Budgeting 1.Adjustment of the discount rate: lower risk rating implies higher risk and higher discount rate. 2.Adjustment of the estimated cash flows: adjust estimates for the probability that cash flows may not be realized. 3.Assessing Risk of Existing Projects: review country risk periodically after project has been implemented.

11. © 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11 Preventing Host Government Takeovers 1.Use a short-term horizon 2.Rely on unique supplies or technology 3.Hire local labor 4.Borrow local funds 5.Purchase insurance 6.Use project finance