IFM_Ch16_country risk

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FINC3240
International Finance
Chapter 16
Country Risk Analysis
1
Country Risk

Political risk

Financial risk
2
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
3
Why Country Risk Analysis Is
Important
1. Definition of Political risk
--is the potential 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
e. The imposition of trade restrictions on imports
4
Political Risk Factors
1. Attitude of Consumers in the Host
Country
e.g. consumers purchase only locally produced goods?
2. Actions of Host Government
imposition of pollution control standards;
additional taxes
withholding taxed
fund transfer restrictions
require the use of local employees
subsidizing local competitors
failure to enforce copyright protections in the software
industry
3. Blockage of Fund Transfers
5
Political Risk Factors
4. Currency Inconvertibility
China Yuan
http://www.reuters.com/article/usDollarRpt/idUSL64476620090606
5. War
The 2003 War in Iraq
6. Bureaucracy
7. Corruption
6
Exhibit 16.1 Corruption Index Ratings (High
ratings indicate low corruption)
7
Financial Risk Factors

Economy
Current and potential state of economy

Interest Rates
High or low

Exchange Rates
Affect import vs export, and thus income

Inflation
Affect purchasing power and demand
8
Types of Country Risk Assessment
1. Macro-assessment---all variables that affect
country risk except those unique to a particular firm
1.)
Political factors
relationship between the two governments
attitude of the host country people toward MNC’s government
historical stability of the host government
probability of war
2.)
Financial factors
GDP growth, inflation trend, host government budget level and
deficit, interest rates, unemployment, foreign exchange control,
etc.
9
Types of Country Risk Assessment
2. Micro-assessment---all variables that
affect country risk that relates to a particular firm
or project.
Example: Country Z (page 487)
10
Techniques to Assess Country Risk
1. Checklist approach
2. Delphi Technique: collecting independent
opinions without group discussion.
3. Quantitative Analysis
regression to find sensitivity
4. Inspection Visits
5. Combination of Techniques
11
Measuring Country Risk
1. Variation in Methods of Measuring
Country Risk
2. Using the Country Risk Rating for
Decision Making
high rating means low risk
12
Determining the Overall Country Risk Rating
13
Exhibit 16.3 Derivation of the Overall Country
Risk Rating Based on Assumed Information
14
Country Risk Ratings across
Countries
1. Vary substantially among countries
2. Higher values represent less risk
especially industrialized countries
Risk ratings change over time
15
Incorporating Country Risk in
Capital Budgeting
1. Adjustment to the Discount Rate
The lower the country risk rating, the higher
country risk, and the higher the discount
rate adjustment
2. Adjustment to the Estimated Cash
Flow
16
Reducing Exposure to Host
Government Takeovers
1. Use a Short-Term Horizon
2. Rely on Unique Supplies or
Technology
3. Hire Local Labor
17
Reducing Exposure to Host
Government Takeovers
4. Borrow Local Funds
5. Purchase Insurance
6. Use Project Finance
MNC invests a limited amount of equity
The project is separated from MNC.
18
Homework 10
Chapter16 Q&A: 5,6,10.
19
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