ch 16 e 8 country risk analysis

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Chapter Objectives

To identify the common factors

used by MNCs to measure a countrys

polit ical risk and financial risk; To explain the techniques used to

measure country risk; and

To explain how MNCs use the assessmentof country risk when making f inancial

decisions.


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Why Country Risk Analysis Is Important

Country risk represents the potentiallyadverse impact of a countrys

environment on an MNCs cash flows.


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Country risk analysis can be used: to monitor countries where the MNC is

currently doing business;

as a screening device to avoid conducting

business in countries with excessive risk;

and

to revise its investment or financingdecisions in light of recent events.

Why Country Risk Analysis Is Important


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Political Risk Factors

Attitude of consumers in the host country Some consumers are very loyal to locally

manufactured products.

Actions of host governmentThe host government may impose special

requirements or taxes, restrict fund

transfers, and subsidize local firms. MNCscan also be hurt by a lack of restrictions,such as failure to enforce copyright laws.


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Blockage of fund transfers If fund transfers are blocked, subsidiaries

will have to undertake projects that may

not be optimal for the MNC.

Currency inconvertibili tyThe MNC parent may need to exchange

earnings for goods if the foreign currencycannot be changed into other currencies.


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War Internal and external battles, or even the

threat of war, can have devastating effects.

Bureaucracy Bureaucracy can complicate businesses.

Corruption

Corruption can increase the cost of

conducting business or reduce revenue.



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Corruption Index Ratings for Selected CountriesMaximum rating = 10. High ratings indicate low corrupt ion.


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Financial Risk Factors

Indicators of economic growthThe current and potential state of a

countrys economy is important since a

recession can severely reduce demand.

A countrys economic growth is dependent

on several financial factors - interest rates,

exchange rates, inflation, etc.


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Types of Country Risk Assessment

A macroassessment of country risk is anoverall risk assessment of a country

without considering the MNCs business.

A microassessment of country risk is therisk assessment of a country with respect

to the MNCs type of business.

The overall assessment thus consists ofmacropolitical risk, macrofinancial risk,

micropolitical risk, and microfinancial risk.


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Note that there is clearly a degree ofsubjectivity in:

identifying the relevant political andfinancial factors,

determining the relative importance of each

factor, and

predicting the values of factors that cannot

be measured objectively.

Types of Country Risk Assessment


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Techniques of

Assessing Country Risk The checklist approach involves rating

and weighting all the macro and micro

political and financial factors to derive anoverall assessment of country risk.

The Delphi technique involves collectingvarious independent opinions and then

averaging and measuring the dispersion

of those opinions.


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Techniques of

Assessing Country Risk Quantitative analysis techniques like

regression analysis can be applied to

historical data to assess the sensitivity ofthe business to various risk factors.

Inspection visits involve traveling to acountry and meeting with government

officials, firm executives, and consumers

to clarify uncertainties.


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Often, firms use a variety of techniques formaking country risk assessments.

For example, they may use the checklistapproach to develop an overall country

risk rating, and some of the other

techniques to assign ratings to the

factors.

Techniques of

Assessing Country Risk


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Measuring Country Risk

The checklist approach involves:

Assigning values and weights to political and

financial risk factors,

Multiplying the factor values with their

weights, and summing up to give the political

and financial risk ratings,

Assigning weights to the risk ratings, andMultiplying the ratings with their weights, and

summing up to give the country risk rating.


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Cougar Co.:Determining the Overall Country Risk Rating


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Cougar Co.:Derivation of the Overall Country Risk Rating


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Comparing Risk Ratings

Among Countries One approach to comparing political and

financial ratings among countries is the

foreign investment risk matrix (FIRM).

The matrix displays financial (oreconomic) and political risk by intervals

ranging from poor to good.

Each country can be positioned on thematrix based on its polit ical and f inancial

ratings.


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Actual Country Risk Ratings Across Countries


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Incorporating Country Risk in

Capital Budgeting If the risk rating of a country is acceptable,

the projects related to that country

deserve further consideration. Country risk can be incorporated into the

capital budgeting analysis of a proposed

project either by adjusting the discount

rate or by adjusting the estimated cash

flows.


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Adjustment of the discount rateThe higher the perceived risk, the higher

the discount rate that should be applied to

the projects cash flows.

Adjustment of the estimated cash flows By estimating how the cash flows could be

affected by each form of risk, the MNC can

determine the probability distribution of the

net present value of the project.

Incorporating Country Risk in

Capital Budgeting


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Spartan, Inc.: Summary of Estimated NPVsAcross Possible Scenarios


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Applications of

Country Risk AnalysisAs a result of the crisis that culminated in

the Gulf War in 1991, many MNCs

reassessed their exposure to country riskand revised their operations accordingly.

The 199798 Asian crisis caused MNCs torealize that they had underestimated the

potential financial problems that could

occur in the high-growth Asian countries.


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Following the September 11, 2001 attackon the United States, some MNCs reduced

their exposure to country risk bydownsizing or discontinuing their

business in countries where U.S. firms

may be subject to more terrorist attacks.

Applications of

Country Risk Analysis


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Reducing Exposure

to Host Government Takeovers The potential benefits of DFI can be offset

by country risk, the most severe of which

is a host government takeover. To reduce the chance of a takeover by the

host government, firms often:

Use a short-term horizonThis technique concentrates on recovering

cash flow quickly.


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Reducing Exposure

to Host Government TakeoversRely on unique supplies or technology

In this way, the host government will not be

able to take over and operate thesubsidiary successfully.

Hire local labor

The local employees can apply pressure

on their government if they are affected by

the takeover.


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Use project finance

Project finance deals are heavily financed

with credit, thus limiting the MNCsexposure. The loans are secured by the

projects future revenues and are

nonrecourse. A bank may guarantee the

payments to the MNC.

Reducing Exposure

to Host Government Takeovers

ch 16 e 8 country risk analysis

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