C H A P T E R 16Country Risk Analysis

Chapter OverviewA. Why Country Risk Analysis Is ImportantB. Political Risk FactorsC. Financial Risk FactorsD. Types of Country Risk AssessmentE. Techniques to Assess Country RiskF. Measuring Country RiskG. Comparing Risk Ratings among CountriesH. Actual Country Risk Ratings across

CountriesI. Incorporating Country Risk in Capital

BudgetingJ. Reducing Exposure to Host Government

Takeovers

Chapter 16 ObjectivesThis chapter will:A. Identify the common factors used by

MNCs to measure a country’s political riskB. 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 riskis the potentially adverse impact of a country’s environment on an MNC’s cash flows

2. Some Adverse Impacts:a. A terrorist attackb. A major labor strike in an industryc. A political crisis due to a scandal within a

countryd. Concern about a country’s banking system that

may cause a major outflow of fundse. The imposition of trade restrictions on

imports

B. Political Risk Factors

1. Attitude of Consumers in the Host Country

2. Actions of Host Governmenta. Lack of Restrictions:

especially copyright protections in the software industry

3. Blockage of Fund Transfers

B. Political Risk Factors4. Currency Inconvertibility

Case in point: Chinese yuan

5. WarThe 2003 War in Iraq

6. Bureaucracy

7. Corruption

C. Financial Risk Factors

1. Indicators of Economic GrowthA country’s economic growth is dependent on several financial factors:

a. Interest Ratesb. Exchange Ratesc. Inflation

D. Types of Country Risk Assessment

1. Macroassessment of Country Riska. Characteristics of the Country:1.) Political factors2.) 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 Matrixa. 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 riska. especially industrialized countriesb. Risk ratings change over time

I. Incorporating Country Risk in Capital Budgeting

1. Adjustment to the Discount Ratea. 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