C H A P T E R 16 Country Risk Analysis

Chapter Overview A. Why Country Risk Analysis Is Important B. Political Risk Factors C. Financial Risk Factors D. Types of Country Risk Assessment E. Techniques to Assess Country Risk F. Measuring Country Risk G. Comparing Risk Ratings among Countries H. Actual Country Risk Ratings across Countries I. Incorporating Country Risk in Capital Budgeting J. Reducing Exposure to Host Government Takeovers

Chapter 16 Objectives This chapter will: A. Identify the common factors used by MNCs to measure a country’s political risk B. Identify the common factors used by MNCs to measure a country’s financial risk C. Explain the techniques used to measure country risk D. Explain how MNCs use the assessment of country risk when making financial decisions

A. Why Country Risk Analysis Is Important 1. Definition of Political risk is the potentially adverse impact of a country’s environment on an MNC’s cash flows 2. Some Adverse Impacts: a. A terrorist attack b. A major labor strike in an industry c. A political crisis due to a scandal within a country d. Concern about a country’s banking system that may cause a major outflow of funds e. The imposition of trade restrictions on imports

B. Political Risk Factors 1. Attitude of Consumers in the Host Country 2. Actions of Host Government a. Lack of Restrictions: especially copyright protections in the software industry 3. Blockage of Fund Transfers

B. Political Risk Factors 4. Currency Inconvertibility Case in point: Chinese yuan 5. War The 2003 War in Iraq 6. Bureaucracy 7. Corruption

C. Financial Risk Factors 1. Indicators of Economic Growth A country’s economic growth is dependent on several financial factors: a. Interest Rates b. Exchange Rates c. Inflation

D. Types of Country Risk Assessment 1. Macroassessment of Country Risk a. Characteristics of the Country: 1.) Political factors 2.) Financial factors b. Uncertainty Surrounding a Macroassessment 2. Microassessment of Country Risk

E. Techniques to Assess Country Risk 1. Checklist approach 2. Delphi Technique: collecting independent opinions without group discussion. 3. Quantitative Analysis 4. Inspection Visits 5. Combination of Techniques

F. Measuring Country Risk 1. Variation in Methods of Measuring Country Risk 2. Using the Country Risk Rating for Decision Making

Determining the Overall Country Risk Rating

G. Comparing Risk Ratings among Countries 1. Create a Foreign Investment Risk Matrix a. which displays the financial (or economic) and political risk by intervals ranging across the matrix from “poor” to “good.” b. Each country can be positioned in its appropriate location on the matrix based on its political rating and financial rating.

H. Actual Country Risk Ratings across Countries 1. Vary substantially among countries 2. Higher values represent less risk a. especially industrialized countries b. Risk ratings change over time

I. Incorporating Country Risk in Capital Budgeting 1. Adjustment to the Discount Rate a. Discount rate on a country project may be adjusted to represent the greater or lesser risk b. The lower the country risk rating, the higher the discount rate adjustment 2. Adjustment of the Estimated Cash Flow

J. Reducing Exposure to Host Government Takeovers 1. Use a Short-Term Horizon 2. Rely on Unique Supplies or Technology 3. Hire Local Labor

J. Reducing Exposure to Host Government Takeovers 4. Borrow Local Funds 5. Purchase Insurance 6. Use Project Finance