Description
This is a presentation about importance of country risk. Various risk factors like political risk factors, financial risk factors are also explained in detail.
Chapter 19
Analyzing Country Risk
Group -2
Ankush Khurana
Shweta Gahlot
Importance of country risk
• Has adverse impact on cash flow.
• Monitor countries for doing business
• Major decision like divesting or franchising can
be taken easily
• Helps in revising financing and investing
decision.
Political risk factors
• Attitudes of consumers in host country
• Local preference by consumers
• Countries exert pressure on consumers(Walmart)
• Joint venture better if loyal consumers
• Host Govt. Actions
• Additional corporate taxes
• Fund transfer restrictions
• High Import duties
• Extra taxes, subsidize competitors
• Lack of restrictions
Political risk factors(cont.)
• Fund transfers blockage
• Some countries block fund transfer to parent company
• Lower return for subsidiaries
• Currency Inconvertibility
• Countries block currency conversion
• Parent company exchanges currency for goods
• War
• Has an impact on the business
• High cost due to safety of employees
• Eg. French tourism affected by differences with US on IRAQ
war.
Political risk factors(cont.)
• Bureaucracy
• High govt. bureaucracy deterrent
• Slow decision making
• Eg. India, Eastern Europe
• Corruption
• Increases the cost of conducting business
• Loss in revenue
• Double standards exist in major countries(U.S)
Financial Risk Factors
• Current & Potential state of Economy
• Subsidiary is affected by the demand of its product
• Recession reduces demand
• Economic growth Indicators
• Interest rates: High interest rates reduces demand and
vice versa.
• Exchange rates: Strong currency reduces demand for
country exports, increases imports.
• Inflation: Affect consumers purchasing power and
therefore demand
Types of Country Risk Assessment
• Macro-assessment of Country risk
• Consideration of all risk factors at macro level
• Remains same for the country irrespective of industry
– Political factors
• Relationship between both the govt.
• Stability of the govt.
• Attitude of people towards MNC
– Financial Factors
• GDP growth
• Inflation
• Interest Rates etc.
Types of Country Risk
Assessment(cont.)
• Micro-assessment of Country Risk
• Specific to the Industry
• Risk varies with firm, industry and project of concern
• Sensitivity of the firm’s business to real GDP growth,
inflation needs
• Overall assessment
• Macropolitical risk
• Macrofinancial risk
• Micropolitical risk
• Macropolitical risk
Techniques to Assess Country Risk
• Checklist Approach
• Ratings are assigned to various risk factors(1-5)
• Some factors subjectively measured
• Weights are assigned to different factors
• Delphi Technique
• Collection of independent opinions
• Based on subjective opinions
• No group discussion, individual opinions
Techniques to Assess Country
Risk(cont)
• Quantitative Analysis
• Regression analysis can be used to assess risk
• Risk modeling can be done
• Inspection Visits
• Meeting govt. officials
• Better judgment of inter-country relationship
Country Risk Rating
• Different country risk assessors have their own
individual procedures for quantifying country risk.
• Although most procedures involve rating and
weighting individual risk factors, the number,
type, rating, and weighting of the factors will vary
with the country being assessed, as well as the
type of corporate operations being planned.
• One can also use risk ratings provided at certain
reliable websites.
Overall risk rating
Weights
30%
70%
Political factors
1.Blockage of
funds
2.Bureaucracy
Financial Factors Weights
1. Interest rate 20%
2. Inflation rate 10
3. Exchange rate 20
4. Industry competition 10
5. Industry growth 40
Overall country risk rating
20%
Political risk rating
Financial risk
rating
80%
20%
Country risk measurement
• Firms may use country risk ratings when
screening potential projects, or when
monitoring existing projects.
• For example, decisions regarding subsidiary
expansion, fund transfers to the parent,
and sources of financing, can all be affected
by changes in the country risk rating.
Comparing Risk Ratings
Among Countries
• One approach to comparing political and
financial ratings among countries is the
foreign investment risk matrix (FIRM ).
• The matrix measures financial (or economic)
risk on one axis and political risk on the other
axis.
• Each country can be positioned on the matrix
based on its political and financial ratings.
Unclear
Zone
Acceptable
Zone
Unacceptable
Zone
Financial Risk Rating
P
o
l
i
t
i
c
a
l
R
i
s
k
R
a
t
i
n
g
Acceptable Unacceptable
S
t
a
b
l
e
U
n
s
t
a
b
l
e
The Foreign Investment Risk Matrix (FIRM)
Actual Country Risk Ratings Across
Countries
• Some countries are rated higher according to
some risk factors, but lower according to
others.
• On the whole, industrialized countries tend to
be rated highly, while emerging countries tend
to have lower risk ratings.
• Country risk ratings change over time in
response to changes in the risk factors.
COUNTRIES (NORTH AND SOUTH
AMERICA)
RATINGS
CANADA, US, ARGENTINA A 1
MEXICO A 4
CHILE A 2
BRAZIL, PERU, COLOMBIA B
JAMAICA C
VENEZUELA, EUCADOR D
Incorporating Country Risk in Capital
Budgeting
• If the risk rating of a country is in the
acceptable zone, the projects related to that
country deserve further consideration.
• Country risk can be incorporated into the
capital budgeting analysis of a project
I. by adjusting the discount rate, or
II. by adjusting the estimated cash flows.
Incorporating Country Risk in Capital
Budgeting
• Adjustment of the Discount Rate
– The higher the perceived risk, the higher the
discount rate that should be applied to the
project’s cash flows.
– Recalculation of discount rate being arbitrary
• 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.
Estimation of NPV
Scenario Withholding
tax imposed
Salvage value
of project
NPV Probability
1 10% $12 mn $ 2.23 mn 0.7*0.6=42%
2 20% $ 12mn $ 1.25 mn 0.3*0.6=18%
3 10% $ 7 mn $ 0.8 mn 0.7*0.4=28%
4 20% $ 7 mn -$0.17 mn 0.3*0.4=12%
E(NPV)= $2.23*0.42 + $1.25*0.18 + $0.8*0.28 + (- $0.17)*0.12
=$1.36
Capital budgeting planning with scenario
estimations. Probability of the two risks are
accounted for by constructing the cash flow
statement and hence NPV under both
Applications of
Country Risk Analysis
• Alerted by its risk assessor, Gulf Oil planned to
deal with the loss of Iranian oil, and was able to
avoid major losses when the Shah of Iran fell four
months later.
• Decisions such as subsidiary expansion, fund
transfers to parent, sources of financing can be
affected by periodic risk assessments.
• However, while the risk assessment of a country
can be useful, it cannot always detect upcoming
crises.
Applications of
Country Risk Analysis
• Iraq’s invasion of Kuwait was difficult to forecast,
for example. Nevertheless, many MNCs promptly
reassessed their exposure to country risk and
revised their operations.
• The 1997-98 Asian crisis also showed that MNCs
had underestimated the potential financial
problems that could occur in the high-growth
Asian countries.
• Thus, preparation to revise the operations in
order to reduce exposure should always be there.
Reducing Exposure
to Host Government Takeovers
• The benefits of FDI 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 the following
strategies:
? Use a Short-Term Horizon
– This technique concentrates on recovering cash
flow quickly.
Reducing Exposure
to Host Government Takeovers
? Rely on Unique Supplies or Technology
In this way, the host government will not be able
to take over and operate the subsidiary
successfully.
? Hire Local Labor
The local employees can apply pressure on their
government.
Reducing Exposure
to Host Government Takeovers
?Borrow Local Funds
– The local banks can apply pressure on their
government.
?Purchase Insurance
– To cover risk of expropriation. For e.g. US
government provides insurance through Overseas
Private Investment Corporation, MIGA of World
Bank
?Minimize exposure
– Form joint ventures with local companies.
• Local government may be less inclined to
expropriate assets from their own citizens.
– Join a consortium of international companies
to undertake FDI.
• Local government may be less inclined to
expropriate assets from a variety of countries all at
once.
Using Project Finance
• Many of world’s largest infrastructure projects are
structured as project finance deals limiting exposure of
MNCs.
• Key points
- MNC exposure limited due to limited amount of equity
invested in the project
- A bank may guarantee payments to MNC
- The deals are secured by future revenues from
production
A host government is unlikely to take over this project
as it would have to assume the existing liabilities due
to credit arrangement.
Impact of Country Risk on an MNC’s
Value
( ) ( ) | |
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)
¦
¦
`
¹
¦
¦
¹
¦
¦
´
¦
+
×
=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
E (CF
j,t
) = expected cash flows in currency j to be received by the
U.S. parent at the end of period t
E (ER
j,t
) = expected exchange rate at which currency j can be
converted to dollars at the end of period t
k = weighted average cost of capital of the parent
Exposure of Foreign Projects to
Country Risks
THANK YOU
ANY QUESTIONS?
doc_659932766.pptx
This is a presentation about importance of country risk. Various risk factors like political risk factors, financial risk factors are also explained in detail.
Chapter 19
Analyzing Country Risk
Group -2
Ankush Khurana
Shweta Gahlot
Importance of country risk
• Has adverse impact on cash flow.
• Monitor countries for doing business
• Major decision like divesting or franchising can
be taken easily
• Helps in revising financing and investing
decision.
Political risk factors
• Attitudes of consumers in host country
• Local preference by consumers
• Countries exert pressure on consumers(Walmart)
• Joint venture better if loyal consumers
• Host Govt. Actions
• Additional corporate taxes
• Fund transfer restrictions
• High Import duties
• Extra taxes, subsidize competitors
• Lack of restrictions
Political risk factors(cont.)
• Fund transfers blockage
• Some countries block fund transfer to parent company
• Lower return for subsidiaries
• Currency Inconvertibility
• Countries block currency conversion
• Parent company exchanges currency for goods
• War
• Has an impact on the business
• High cost due to safety of employees
• Eg. French tourism affected by differences with US on IRAQ
war.
Political risk factors(cont.)
• Bureaucracy
• High govt. bureaucracy deterrent
• Slow decision making
• Eg. India, Eastern Europe
• Corruption
• Increases the cost of conducting business
• Loss in revenue
• Double standards exist in major countries(U.S)
Financial Risk Factors
• Current & Potential state of Economy
• Subsidiary is affected by the demand of its product
• Recession reduces demand
• Economic growth Indicators
• Interest rates: High interest rates reduces demand and
vice versa.
• Exchange rates: Strong currency reduces demand for
country exports, increases imports.
• Inflation: Affect consumers purchasing power and
therefore demand
Types of Country Risk Assessment
• Macro-assessment of Country risk
• Consideration of all risk factors at macro level
• Remains same for the country irrespective of industry
– Political factors
• Relationship between both the govt.
• Stability of the govt.
• Attitude of people towards MNC
– Financial Factors
• GDP growth
• Inflation
• Interest Rates etc.
Types of Country Risk
Assessment(cont.)
• Micro-assessment of Country Risk
• Specific to the Industry
• Risk varies with firm, industry and project of concern
• Sensitivity of the firm’s business to real GDP growth,
inflation needs
• Overall assessment
• Macropolitical risk
• Macrofinancial risk
• Micropolitical risk
• Macropolitical risk
Techniques to Assess Country Risk
• Checklist Approach
• Ratings are assigned to various risk factors(1-5)
• Some factors subjectively measured
• Weights are assigned to different factors
• Delphi Technique
• Collection of independent opinions
• Based on subjective opinions
• No group discussion, individual opinions
Techniques to Assess Country
Risk(cont)
• Quantitative Analysis
• Regression analysis can be used to assess risk
• Risk modeling can be done
• Inspection Visits
• Meeting govt. officials
• Better judgment of inter-country relationship
Country Risk Rating
• Different country risk assessors have their own
individual procedures for quantifying country risk.
• Although most procedures involve rating and
weighting individual risk factors, the number,
type, rating, and weighting of the factors will vary
with the country being assessed, as well as the
type of corporate operations being planned.
• One can also use risk ratings provided at certain
reliable websites.
Overall risk rating
Weights
30%
70%
Political factors
1.Blockage of
funds
2.Bureaucracy
Financial Factors Weights
1. Interest rate 20%
2. Inflation rate 10
3. Exchange rate 20
4. Industry competition 10
5. Industry growth 40
Overall country risk rating
20%
Political risk rating
Financial risk
rating
80%
20%
Country risk measurement
• Firms may use country risk ratings when
screening potential projects, or when
monitoring existing projects.
• For example, decisions regarding subsidiary
expansion, fund transfers to the parent,
and sources of financing, can all be affected
by changes in the country risk rating.
Comparing Risk Ratings
Among Countries
• One approach to comparing political and
financial ratings among countries is the
foreign investment risk matrix (FIRM ).
• The matrix measures financial (or economic)
risk on one axis and political risk on the other
axis.
• Each country can be positioned on the matrix
based on its political and financial ratings.
Unclear
Zone
Acceptable
Zone
Unacceptable
Zone
Financial Risk Rating
P
o
l
i
t
i
c
a
l
R
i
s
k
R
a
t
i
n
g
Acceptable Unacceptable
S
t
a
b
l
e
U
n
s
t
a
b
l
e
The Foreign Investment Risk Matrix (FIRM)
Actual Country Risk Ratings Across
Countries
• Some countries are rated higher according to
some risk factors, but lower according to
others.
• On the whole, industrialized countries tend to
be rated highly, while emerging countries tend
to have lower risk ratings.
• Country risk ratings change over time in
response to changes in the risk factors.
COUNTRIES (NORTH AND SOUTH
AMERICA)
RATINGS
CANADA, US, ARGENTINA A 1
MEXICO A 4
CHILE A 2
BRAZIL, PERU, COLOMBIA B
JAMAICA C
VENEZUELA, EUCADOR D
Incorporating Country Risk in Capital
Budgeting
• If the risk rating of a country is in the
acceptable zone, the projects related to that
country deserve further consideration.
• Country risk can be incorporated into the
capital budgeting analysis of a project
I. by adjusting the discount rate, or
II. by adjusting the estimated cash flows.
Incorporating Country Risk in Capital
Budgeting
• Adjustment of the Discount Rate
– The higher the perceived risk, the higher the
discount rate that should be applied to the
project’s cash flows.
– Recalculation of discount rate being arbitrary
• 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.
Estimation of NPV
Scenario Withholding
tax imposed
Salvage value
of project
NPV Probability
1 10% $12 mn $ 2.23 mn 0.7*0.6=42%
2 20% $ 12mn $ 1.25 mn 0.3*0.6=18%
3 10% $ 7 mn $ 0.8 mn 0.7*0.4=28%
4 20% $ 7 mn -$0.17 mn 0.3*0.4=12%
E(NPV)= $2.23*0.42 + $1.25*0.18 + $0.8*0.28 + (- $0.17)*0.12
=$1.36
Capital budgeting planning with scenario
estimations. Probability of the two risks are
accounted for by constructing the cash flow
statement and hence NPV under both
Applications of
Country Risk Analysis
• Alerted by its risk assessor, Gulf Oil planned to
deal with the loss of Iranian oil, and was able to
avoid major losses when the Shah of Iran fell four
months later.
• Decisions such as subsidiary expansion, fund
transfers to parent, sources of financing can be
affected by periodic risk assessments.
• However, while the risk assessment of a country
can be useful, it cannot always detect upcoming
crises.
Applications of
Country Risk Analysis
• Iraq’s invasion of Kuwait was difficult to forecast,
for example. Nevertheless, many MNCs promptly
reassessed their exposure to country risk and
revised their operations.
• The 1997-98 Asian crisis also showed that MNCs
had underestimated the potential financial
problems that could occur in the high-growth
Asian countries.
• Thus, preparation to revise the operations in
order to reduce exposure should always be there.
Reducing Exposure
to Host Government Takeovers
• The benefits of FDI 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 the following
strategies:
? Use a Short-Term Horizon
– This technique concentrates on recovering cash
flow quickly.
Reducing Exposure
to Host Government Takeovers
? Rely on Unique Supplies or Technology
In this way, the host government will not be able
to take over and operate the subsidiary
successfully.
? Hire Local Labor
The local employees can apply pressure on their
government.
Reducing Exposure
to Host Government Takeovers
?Borrow Local Funds
– The local banks can apply pressure on their
government.
?Purchase Insurance
– To cover risk of expropriation. For e.g. US
government provides insurance through Overseas
Private Investment Corporation, MIGA of World
Bank
?Minimize exposure
– Form joint ventures with local companies.
• Local government may be less inclined to
expropriate assets from their own citizens.
– Join a consortium of international companies
to undertake FDI.
• Local government may be less inclined to
expropriate assets from a variety of countries all at
once.
Using Project Finance
• Many of world’s largest infrastructure projects are
structured as project finance deals limiting exposure of
MNCs.
• Key points
- MNC exposure limited due to limited amount of equity
invested in the project
- A bank may guarantee payments to MNC
- The deals are secured by future revenues from
production
A host government is unlikely to take over this project
as it would have to assume the existing liabilities due
to credit arrangement.
Impact of Country Risk on an MNC’s
Value
( ) ( ) | |
( )
¿
¿
¦
¦
)
¦
¦
`
¹
¦
¦
¹
¦
¦
´
¦
+
×
=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
E (CF
j,t
) = expected cash flows in currency j to be received by the
U.S. parent at the end of period t
E (ER
j,t
) = expected exchange rate at which currency j can be
converted to dollars at the end of period t
k = weighted average cost of capital of the parent
Exposure of Foreign Projects to
Country Risks
THANK YOU
ANY QUESTIONS?
doc_659932766.pptx