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Country Risk Analysis
South-Western/Thomson Learning © 2006
Slides by Yee-Tien (Ted) Fu
To identify the common factors used by MNCs to measure a country’s political risk and financial risk; To explain the techniques used to measure country risk; and To explain how MNCs use the assessment of country risk when making financial decisions.
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Why Country Risk Analysis Is Important • Country risk represents the potentially adverse impact of a country’s environment on an MNC’s cash flows. 16 .3 .
as a screening device to avoid conducting business in countries with excessive risk. and to revise its investment or financing decisions in light of recent events.4 . 16 .Why Country Risk Analysis Is Important • Country risk analysis can be used: ¤ ¤ ¤ to monitor countries where the MNC is currently doing business.
such as failure to enforce copyright laws.Political Risk Factors • Attitude of consumers in the host country ¤ Some consumers are very loyal to locally manufactured products. • Actions of host government ¤ 16 . MNCs can also be hurt by a lack of restrictions.5 . and subsidize local firms. The host government may impose special requirements or taxes. restrict fund transfers.
Political Risk Factors • Blockage of fund transfers ¤ If fund transfers are blocked. • Currency inconvertibility ¤ 16 . The MNC parent may need to exchange earnings for goods if the foreign currency cannot be changed into other currencies.6 . subsidiaries will have to undertake projects that may not be optimal for the MNC.
• Bureaucracy ¤ • Corruption ¤ 16 . Bureaucracy can complicate businesses. Corruption can increase the cost of conducting business or reduce revenue.7 . can have devastating effects. or even the threat of war.Political Risk Factors • War ¤ Internal and external battles.
Corruption Index Ratings for Selected Countries Maximum rating = 10.8 . High ratings indicate low corruption. 16 .
etc. exchange rates.Financial Risk Factors • Indicators of economic growth ¤ ¤ The current and potential state of a country’s economy is important since a recession can severely reduce demand. A country’s economic growth is dependent on several financial factors . inflation. 16 .interest rates.9 .
10 . micropolitical risk. and microfinancial risk. macrofinancial risk. • A microassessment of country risk is the risk assessment of a country with respect to the MNC’s type of business.Types of Country Risk Assessment • A macroassessment of country risk is an overall risk assessment of a country without considering the MNC’s business. • The overall assessment thus consists of macropolitical risk. 16 .
11 .Types of Country Risk Assessment • Note that there is clearly a degree of subjectivity in: ¤ identifying the relevant political and financial factors. and ¤ predicting the values of factors that cannot be measured objectively. 16 . ¤ determining the relative importance of each factor.
Techniques of Assessing Country Risk • The checklist approach involves rating and weighting all the macro and micro political and financial factors to derive an overall assessment of country risk.12 . 16 . • The Delphi technique involves collecting various independent opinions and then averaging and measuring the dispersion of those opinions.
• Inspection visits involve traveling to a country and meeting with government officials. firm executives.13 . and consumers to clarify uncertainties.Techniques of Assessing Country Risk • Quantitative analysis techniques like regression analysis can be applied to historical data to assess the sensitivity of the business to various risk factors. 16 .
• For example. and some of the other techniques to assign ratings to the factors. firms use a variety of techniques for making country risk assessments. they may use the checklist approach to develop an overall country risk rating.Techniques of Assessing Country Risk • Often. 16 .14 .
and summing up to give the country risk rating. Multiplying the factor values with their weights.15 . and summing up to give the political and financial risk ratings. and Multiplying the ratings with their weights. Assigning weights to the risk ratings.Measuring Country Risk The checklist approach involves: Assigning values and weights to political and financial risk factors. 16 .
: Determining the Overall Country Risk Rating 16 .16 .Cougar Co.
17 .: Derivation of the Overall Country Risk Rating 16 .Cougar Co.
as well as the type of operations being planned. and when monitoring existing projects.Measuring Country Risk • The procedures for quantifying country risk will vary with the assessor. the country being assessed. 16 .18 . • Firms use country risk ratings when screening potential projects.
19 .” • Each country can be positioned on the matrix based on its political and financial ratings. 16 .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 (or economic) and political risk by intervals ranging from “poor” to “good.
20 .Actual Country Risk Ratings Across Countries 16 .
16 .21 .Incorporating Country Risk in Capital Budgeting • If the risk rating of a country is acceptable. • 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. the projects related to that country deserve further consideration.
the MNC can determine the probability distribution of the net present value of the project. 16 . By estimating how the cash flows could be affected by each form of risk. the higher the discount rate that should be applied to the project’s cash flows.Incorporating Country Risk in Capital Budgeting • Adjustment of the discount rate ¤ The higher the perceived risk.22 • Adjustment of the estimated cash flows ¤ .
: Summary of Estimated NPVs Across Possible Scenarios 16 .23 . Inc.Spartan.
many MNCs reassessed their exposure to country risk and revised their operations accordingly. 16 .24 . • The 1997–98 Asian crisis caused MNCs to realize that they had underestimated the potential financial problems that could occur in the high-growth Asian countries.Applications of Country Risk Analysis • As a result of the crisis that culminated in the Gulf War in 1991.
firms may be subject to more terrorist attacks. 2001 attack on the United States. 16 . some MNCs reduced their exposure to country risk by downsizing or discontinuing their business in countries where U.S.25 .Applications of Country Risk Analysis • Following the September 11.
the most severe of which is a host government takeover. 16 . firms often: Use a short-term horizon ¤ This technique concentrates on recovering cash flow quickly. • To reduce the chance of a takeover by the host government.26 .Reducing Exposure to Host Government Takeovers • The potential benefits of DFI can be offset by country risk.
27 . the host government will not be able to take over and operate the subsidiary successfully. Hire local labor ¤ 16 .Reducing Exposure to Host Government Takeovers Rely on unique supplies or technology ¤ In this way. The local employees can apply pressure on their government if they are affected by the takeover.
or an international agency insure to some extent various forms of country risk. 16 .Reducing Exposure to Host Government Takeovers Borrow local funds ¤ The local banks can apply pressure on their government if they are affected by the takeover. Investment guarantee programs offered by the home country. host country.28 Purchase insurance ¤ .
The loans are secured by the project’s future revenues and are “nonrecourse. thus limiting the MNC’s exposure.Reducing Exposure to Host Government Takeovers Use project finance ¤ Project finance deals are heavily financed with credit. 16 .29 .” A bank may guarantee the payments to the MNC.
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