INTRODUCTION TO INTERNATIONAL FINANCE

UNIT-1

INTERNATIONAL FINANCE: concept & role of international finance manager in multinational corporations. INTERNATIONAL FINANCIAL ENVIRONMENT: international transactions & financial market, trade & capital flow, inflation, exchange control & currency devaluation, ex-proprietary action etc. Different types of risks: country risk analysis. Unit - II Foreign direct investment & foreign institutional investment foreign collaboration trends since liberalisation. Financial operations of multinational corporation: sources & investment: short, medium & long term national currency financing foreign currency financing, regional & national development finance, private investment companies, Multilateral financial institution : WB/IMF, ADB. Export & import financing: role of commercial banks. Basic instruments, private nonbank sources of finance. Unit - III Financial innovation & risk sharing: introduction, futures markets in growing world, financial future trading, role of financial futures, swap markets, basic swap structure, interest rate, fixed rates currency, currency coupon, types. International stock exchanges: New York, London, Luxemburg, third world and Asian stock exchanges: working and their influences, the securities market, bond market, foreign portfolio investment. Unit - IV New developments in international finance: country funds, ADR, GDR, EURO issues, ECBs, their process of issue, benefits, limitations & specific guidelines issued by Foreign Investment Promotion Board (FIPB). International financial investment strategies and regulations for Indian Companies. FEMA.

Introduction
IF is defined as Management of financial operations of different international activities of an organisation . It includes import and export of goods & services, collaborations etc.

 International companies are importers and exporters, they have no investment outside of their home country. Multinational companies have investment in other countries, but do not have coordinated product offerings in each country. More focused on adapting their products and service to each individual local market. Global companies have invested and are present in many countries. They market their products through the use of the same coordinated image/brand in all markets. Generally one corporate office that is responsible for global strategy. Emphasis on volume, cost management

and efficiency.
Transnational companies are much more complex organizations. They have invested in foreign operations, have a central corporate facility but give decision-making, R&D and marketing powers to each individual foreign market.

MNC VS TNC
MNC is one that has operating subsidiaries,
branches, or affiliates located in foreign

companies.
TNC are the firms whose ownership dispersed internationally. These are usually managed from a global perspective rather than from a global perspective of any single country.

Intl Financial Mgt.

It deals with: Investment decision : Involves capital decisions of different countries. Financial Decision: Deals with the different sources that can be used for financing international capital budgeting. Money Mgt. Decisions: Involves in managing firms financial resources most efficiently.

Similarities between financial mgt. & IFM

Objective of profit maximisation and wealth maximization. Financing decisions such as investment, financing and asset management decisions are same for domestic FM and IFM

Differences b/w DFM & IFM

1. 2. ENVIRONMENT : known, each country has known environment. CORPORATE GOVERNANCE: Rules, Regulations and Institutions are well known. RECORDING TRANSACTIONS : Recorded only in domestic currency. FINANCIAL ANALYSIS: Foreign exchange rates are not included . TRANSACTION EXPOSURE: No transaction exposure. POLITICAL RISK : Negligible in Nature MODIFICATIONS OF FINANCE THEORIES: NO Need. MODIFICATIONS OF FINANCIAL INSTRUMENTS AND USE OF THEM ; may or may be not
1. 2. Not known, each foreign country has its own unique environment and may not be possible to understand by MNC management. Rules, Regulations and Institutions in foreign countries are totally different and may not be known. Received in different countries based on the penetration of the company. Foreign exchange rates are included in financial analysis. yes, transaction exposure is there, since all foreign subsidiaries accounts have to be converted into domestic currency and to prepare consolidated report. High political risk due to location of subsidiaries and branches across the countries. Need to be modified in the areas like capital budgeting and cost of capital. Need to be utilized the new financial instruments like derivatives, letter of credit.(L/C)

3. 4. 5.

3. 4. 5.

6. 7.
8.

6. 7. 8.

FACTORS CONSTRANING MNCs EFFORT TO MAXIMISE RETURNS

ENVIRONMENTAL CONSTRAINTS : Each country enforces its own environmental constraints. Building codes, disposal of waste materials, and pollution controls are few examples of constraints. Compliance on these is additional cost to subsidiaries.

REGULATORY CONSTRAINTS : Each country also enforces its own regulatory constraints pertaining to taxes, currency convertibility rules, earning remittance restrictions and other regulations that can affect cash inflows of a subsidiary established located in host country. Because these type of regulations influence cash flows, they need to be recognized by financial managers while assessing financial policies.
ETHICAL CONSTRAINTS: Each practices vary from country to country. For example bribary is an accepted practice in some countries but it is prohibited in some others. The variation in ethical practices put on MNC in dilemma. That is if it does offer bribes, its reputation receives beating. On the other hand, if it does not offer bribes, it tends to lose out on business to competitors

Reasons for GLOBAL

To expand market: After a company has saturated home country market, which does

ROLE OF IF MANAGER
In a world in which change is the rule and not the exception, the key to international competitiveness is the ability of management to adjust to change and volatility at an ever faster rate. In the words of General Electric Chairman Jack Welch, Im not here to predict the world. Im here to be sure Ive got a company that is strong enough to respond to whatever happens. The rapid pace of change means that new global managers need detailed knowledge of their operations. Global managers must know how to make the products, where the raw materials and parts come from, how they get there, the alternatives, where the funds come from, and what their changing relative values do to the bottom line. They must also understand the political and economic choices facing key nations and how those choices will affect the outcomes of their decisions.

 Develop customized international trade finance solutions to enhance our profitability on international business. Develop customer and informational relationships, to foster higher return/lower risk international trade. Maintain contact with international banks, agents, credit insurance carriers, and others for risk information about a country or customer. Monitor and analyze the political risk of foreign countries; systematize the Company's exposure to customer, political and transactional risk. Establish the parameters for determining acceptable risk to the

Company.

INTERNATIONAL FINANCIAL ENVIRONMENT

Intl Environment

Intl Financial Mkt.

Foreign Exchange Mgt

Host Countrys environment

Intl Monetary system

Intl Banking

Political environment

Intl Banks

Foreign exchange dealers Organised exchanges

Social economic environment

Cultural values and aspirations

Multilateral Financial Institutions

Intl Banking
It is linked to the development of world trade. Emergence of global corporations has been a key driver in the growth of international banking. For instance, the growth of mega multinational corporations in 20th century in America and Europe, and latter in Japan, set off a global expansion of banks domiciled in these countries. Traditionally banks expanded internationally to facilitate intl trade as well as to play the financial intermediation role , as deposit takers ad lenders , in multi national context. This traditional role has been rapidly superseded by the need (A) To offer sophisticated financial instruments like derivates to help clients hedge against exchange rate and interest rate risks arising primarily for there operations across several geographies (b) To build or t be an integral part of a cross-currency payments and settlements systems that enables delivery of funds anywhere in the globe in the most secured and speedy manner.

Structure of International banking(pG Apte)

Due to significant costs associated with doing business internationally compounded by the stringent regulatory restrictions by the banking regulators in most countries it is not alwaz viable for banks to expand internationally. The structure of intl banking

therefore provides a number of alternatives for banks to grow there international

operations in a phased manner. (A) Correspondent Banking :(B) Representative Office :(C) Foreign branch Office :(D) Banking Subsidiary :-

International Monetary system

The international monetary system consists of Elements such as laws, rules, agreements, institutions, mechanisms and procedures which affect foreign exchange rate, balance of payments adjustments, international trade and capital flows. The international monetary system plays a crucial role in the financial management of a multinational business and economic and financial policies of each country.

 As various nations may have varying monetary standards, an international monetary system is required to define a common standard of value for various currencies. A monetary standard is a standard monetary unit that acts as a medium of exchange and a measure of the value of goods and services in a country. The monetary standard of a nation influences national as well as international economic operation. A countrys standard monetary unit or standard money may be different things like gold, silver and paper.

Eg. Metallic standard

The value of the monetary unit is expressed in terms of a fixed quantity and fineness of a metal like gold or silver. If the monetary unit of a country is made of only one metal, the system is known as monometallism.

 FIAT MONEY:- Even if paper money is not convertible into any metal, people accept it because it is the legal tender, and this is why paper is known as fiat money. Mint parity or Gold parity:- When the value of the monetary unit of each country is fixed in terms of gold, the exchange rate is also automatically fixed by mint parity or gold parity.

Alternative Exchange Rate Systems (Obvious but important point)

People trade currencies for two primary reasons
To buy and sell goods and services To buy and sell financial assets

There are an enormous number of exchange rate systems, but generally they can be sorted into one of these categories
Freely Floating Managed Float Target Zone Fixed Rate

Important Note:
Even though we may call it free float in fact the government can still control the exchange rate by manipulating the factors that affect the exchange rate (i.e., monetary policy)

Under a floating rate system, exchange rates are set by demand and supply.
price levels interest rates economic growth

Alternate exchange rate systems: Managed Float (Dirty Float)

Market forces set rates unless excess volatility occurs, then, central bank determines rate by buying or selling currency. Managed float isnt really a single system, but describes a continuum of systems Smoothing daily fluctuations Leaning against the wind slowing the change to a different rate Unofficial pegging: actually fixing the rate without saying so. Target-Zone Arrangement: countries agree to maintain exchange rates within a certain bound What makes target zone arrangements special is the understanding that countries will adjust real economic policies to maintain the zone.

Fixed Rate System: Government maintains target rates and if rates threatened, central banks buy/sell currency. A fixed rate system is the ultimate good news bad news joke. The good is very good and the bad is very bad.
Advantage: stability and predictability Disadvantage: the country loses control of monetary policy (note that monetary policy can always be used to control an exchange rate). Disadvantage: At some point a fixed rate may become unsupportable and one country may devalue. (Argentina is the most dramatic recent example.) As an alternative to devaluation, the country may impose currency controls.

Evolution of International Monetary System

Can be analysed in four stages as follows:1. The Gold standard,1876-1913 2. The inter-war years,1914-1944 3. The Bretton Woods System,1945-1973 4. Flexible Exchange Rate Regime since 1973

 At present the money of most countries has no intrinsic value (if you melt a quarter, you dont get $.25 worth of metal). But historically many countries have backed their currency with valuable commodities (usually gold or silver)if the U.S. treasury were to mint gold coins that had 1/35th ounces of gold and sold these for $1.00, then a dollar bill would have an intrinsic value. When a countrys currency has some intrinsic value, then the exchange rate between the two countries is fixed. For example, if the U.S. mints $1.00 coins that contain 1/35th ounces of gold and Great Britain mints 1.00 coins that contain 4/35th ounces of gold, then it must be the case that 1 = $4 (if not, people could make an unlimited profit buying gold in one country and selling it in another)

The Intrinsic Value of Money and Exchange Rates

THE GOLD STANDARD,1876-1913

In the early days , gold was used as a storage of wealth and as a medium of exchange . The classical gold standard thus lasted for approximately 40 years. The centre of the international financial system during this period was London reflecting its important position in international business and trade . The fundamental principle of the classical gold standard was that each country should set a power value for its currency in terms of gold and then try to maintain this value . Thus , each country had to establish the rate at which its currency could be converted to the weight of gold . Also , under the gold standard , the exchange rate between any two currencies was determined by their gold content.

Three Important Features

1. The government of each country defines its national monetary unit in terms of gold. 2. Free import or export of gold. 3. Two-way convertibility between gold and national currencies at a stable ratio

Under the gold standard, any disequilibrium in the balance of payments of a country is adjusted through a mechanism called PRICE SPECIE automatic adjustment mechanism. A deficit in the balance of payments means that there is excess demand for gold. It implies that the country should sell gold from its reserves, which has the effect of reducing the money supply in the economy. This inturn, will cause a fall in general prices. Consequently, the exports of the country will become more competitive i.e. Exports will increase leading to a decline in the balance of payments deficit of the country.

Example
Suppose the United States buys more goods and services from India than Indians buy from United States. Net Exports from India to the US will be accompanied by a net flow of gold from the United states to India. As more gold leaves the US than arrives, general prices in the US economy will fall. At the same time, general prices in India will increase. Lower prices in the US will make US goods relatively cheaper and Indian goods relatively more expensive . So, the demand for US goods in India will increase, ultimately leading to a reduction in the US balance of payments deficit. The reverse process will occur in India

The Bretton Woods System,19451972

The depression of the 1930s , followed by another war, had vastly diminished commercial trade, the international exchange of currencies and cross-border lending and borrowings. What was left only memories of what the system had once been. Revival of the system began with the bretton Woods agreement that emerged from the international Monetary And financial conference of the united and associated nation in july 1944 at bretton woods Hampshire.

negotiators at Bretton Woods made certain recommendations in 1944

Each nation should be at liberty to use macroeconomics policies for full employment (This tenet ruled out a return to the gold standard) A monetary system was needed that would recognize that exchange rates were both a national and an international concern. The agreement established a dollar based International Monetary System and created two new institution: The International Monetary(IFM) and The International Bank for Reconstruction and Development (World Bank). The basic role of the IFM would be to help countries with balance with post-war reconstruction and general economic development.

main points of the post-war system evolving from the Bretton Woods
A new institution , International Montery Fund(IMF),would be established in Washington DC. Its purpose would be to lend foreign exchange to any member whose supply of foreign exchange had became scarce. This lending Would not be automatic but would be conditional on the members pursuit of economic policies consistent with the other points of the agreement, a determination that would made by IMF. The US Dollar(and, de facto,the british pound)would be designated as reserve currencies, and other nation would maintain there foreign exchange reserves principally in the form of Dollar or Pounds

INTERNATIONAL TRANSACTIONS

INTERNATIONAL TRANSACTIONS

International transactions
In an international transactions a set of trade terms is often used to describe the rights and responsibilities of the buyers and the sellers with regard to sale and transport of goods . Uniform rules interpreting international commercial terms (Incoterms) and defining the cost, risk , and the obligations of the buyers and the sellers in international transactions have been developed by the international chamber of commerce(ICC) in Paris

 These INCOTERMS were first published in 1936 and had subsequently been revised to account for changing modes of transport and document delivery. Incoterms 2000 are the current version inforce. Although it is difficult to cover all possible legal and transportation issues in an international transactions, INCOTERMS provide a sort of contractual shorthand among various parties

 Intl Transactions in trade and economic and commercial transactions as between nations result in many risk of which foreign exchange risk are most prominent. The corporate which are more directly affected are the mncs result involve the transfers of currencies across different nations, receipt and payment in foreign currency ..

FIRM
An MNC may evaluate country risk for several countries, perhaps to determine where to establish a subsidary . One approach to

comparing political and financial ratings among countries,

advocated by some foreign risk managers , is a foreign investment risk matrix (firm) , which displays the financial(or

economic) and political risk by intervals ranging across the

matrix from poor to good. Each country can be positioned in its appropriate location on the matrix based on its political rating and financial rating

THE BOP
The BoP is an a/cing record of all economic transactions between the residents of a country and residents of foreign countries.

Consider an export from India to say Germany. This leads to payment from Germany to a resident exporter and hence according to rule (a) it should be recorded as a credit. The German importer pays the Indian exporter with Euro draft drawn on a German bank say Commerzbank. The exporter sells this draft to his Indian bank say SBI. SBI sends this draft to its correspondent bank in frankfurt say Deutschebank. Deutschebank collects on it and credits the amount to SBIs account with itself. This leads to an increase in SBIs foreign assets- a use of foreign exchange and hence according to rule (b) A debit entry which offsets the credit entry. The credit entry will be made in current account while the offsetting debit entry in the capital account.

Components of the BOP

The Current Account: Under this are included imports and exports of goods and services and unilateral transfers of cash, goods and services. The Capital Account : Under this are grouped transactions leading to changes in foreign financial assets and liabilities of the country. The Reserve Account : In principle, this no different from the capital account in as much as it also relates to financial assets and liabilities.

CAPITAL FLOW
Foreign Direct Investment (FDI)
investment in foreign companies for management and control

Portfolio Investment
investment in foreign companies for capital gain (not concern for management) great implications for crisis

Capital Flow
Capital flows represents the third category of capital account and represents claims with a maturity of less than one year. Such claims include bank deposits, short term loans, short term securities, money market investments and so forth. These investments are quite sensitive to both changes in relative interest rates between countries and anticipated change in the exchange rate. For Example, If interest rates rise in India, with other variables remaining constant, India will experience capital inflows as investors would like to deposit or invest in India to take advantage of higher interest rate. But if the higher interest rate is accompanied by expected depreciation of the Indian rupee, capital inflows to India may not materialize.

TYPES OF CAPITAL FLOWS

Short term capital flows are of two types:
1) Non- Liquid short term capital and 2) Liquid short term capital. Non- Liquid short term capital flows include bank loans and other short term funds that are very difficult to liquidate quickly without loss. Liquid short term capital flows represent claims, Such as demand deposits and short term securities that are easy to liquidate with minimum or no loss.

INFLATION
Changes in the relevant inflation rates can affect international trade activity, which influences exchange rates. If a country inflation rate rises with which it trades, its current a/c will be expected to decrease, other things being equal. Consumers & corporation in that country will most likely purchase more goods overseas (due to high local inflation, while the countrys exports to other countries will decline.

Example of Inflation
Consider how demand and supply schedule would be affected if US inflation suddenly increased substantially while British inflation remain the same. Assume that both British and US firms sells goods that can serve as substitute for each other. The sudden jump in US inflation should cause an increase in the US demand for British goods and therefore also cause an increase in US demand for British pounds. In addition, the jump in US inflation shd. Reduce the british desire for US goods and therefore reduce the supply pounds for sale. At the previous eq. Exchange rate of 1.55 $ there will be a shortage of pounds in the foreign exchange mkt.. The increased US demand for pounds and the reduced supply of pounds for sale place upward pressure on the value of the pound

EXCHANGE CONTROL

CURRENCY DEVALUATION
Definition of Devaluation: A devaluation is when a country makes a conscious decision to lower its exchange rate in a fixed or semi fixed exchange rate. Therefore, technically a devaluation is only possible if a country is a member of some fixed exchange rate policy. For example in the late 1980s, the UK joined the Exchange Rate Mechanism (ERM). Initially the value of the Pound was set between say 3DM and 3.2DM. However, if the government thought that was too high, they could make the decision to devalue and change the target exchange rate to 2.7DM and 2.9DM.

Definition of depreciation
When there is a fall in the value of a currency in a floating exchange rate. This is not due to a governments decision but due to supply and demand side factors. Although if the government sold alot of Pounds they could help the depreciation. For example, the dollar has depreciated in value against the Euro during the last 12 months. This is due to market forces, there is no fixed exchange rate target for Euro to Dollar. The problem is that in everyday use, people take about a devaluation in the dollar, when actually they technically speaking mean a depreciation in the dollar.

Exproprietory Action

Introduction
Exproprietory action falls within the assessment of political risk of the country risk analysis. Host governments can make the MNCs operations to coincide with its own goals. For example: it may require the use of local employees for managerial positions at a subsidiary. In addition it may require social facilities or special environmental controls. The most severe country risk is a host government takeover i.e. expropriation or Expropriatory action.

Meaning of Exproprietory Action

Meaning of expropriation from view point of Corporation is Expropriation means pure nationalization of ownership and complete involvement in the operation by the national government. Generally expropriation refers to an increased and substantial operating involvement by the host government that causes a downward revision to the initial understanding, the parent corporations management role and cash flows from the operation. What is expropriated is the owners right to operate fully the corporation.

 Less developed countries of the world clarified their legal position on expropriation on December 14, 1962. Resolution of The UN General Assembly on permanent sovereignty over National Resources. Section 4 of Resolution stated: Nationalization, expropriation or requisitioning shall be based on grounds or reasons of public utility, security or the national interest which are recognized as overriding of purely individual or private interests both domestic and foreign. In such cases owner shall be paid appropriate compensation, in accordance with the rules in force in the State taking such measures in the exercise of its sovereignty and in accordance with international laws. In any case where the question of compensation gives rise to any controversy, the national jurisdiction of the State taking such measures shall be exhausted. However, upon agreement by sovereign States and other parties concerened, settlement of dispute should be made through arbitration or international adjudication.

REASONS FOR EXPROPRITARY ACTION

1. The foreigners days are marked if foreign investors presence doesnt continue to be appreciated by the local administration. 2. Host country may develop alternative sources of technology and capital. The growth strategy of the nation may shift from one which courts foreign investment at almost any price to one of hard- headed business calculations where in the foreign investor is welcome but only if he brings in and maintains a highly valued resource which is otherwise unavailable locally. 3. Foreign companies can compete unfairly because they have assess to virtually unlimited supply of capital.

4. The remittance of dividends, royalty payments and fees to the parent company constitutes a damaging and endless drain on the host countrys balance of international payments. 5. The foreign investors have in some industries and some countries, allegedly gained control thereby exposing the capital importing country to the dangers of monopolistic practices and strategies dictated. 6. The foreign investor is often unmindful of existing business practices and therefore makes business life uncomfortable or even impossible for the indigenous entrepreneur or industrial worker. These complaints are frequently voiced vis a vis cut throat competition for market share or practice of laying off workers when sales decline or the policy of attracting a significant share of the best quality managers. (THREAT TO LOCAL ENTERPRENUERS

TECHNIQUES TO ALTER PROBABILITIES OF EXPROPRIATATION

COPING WITH POLITICAL RISK:

Direct Positive Approach

Indirect Positive Approach

Direct Positive Approach

Prior negotiations of control and operating contracts. Prior agreement for sale. Joint venture with government or local private sector.

Negative Approach
License or patent restrictions under international agreements. Control of external raw material. Control of transportation to external markets. Control of downstream processing. Control of external markets.

Indirect Positive Approach

Use of locals in management. Joint venture with local banks. Equity participation with middle class Local sourcing Local retail outlets.

External Approaches to Minimize Loss

International insurance or investment guarantees Thinly capitalized firms: Local financing External financing secured only by the local operations.

Ex- Proprietary Action

It is just as a political risk where there is the possibility that the host country will take over a subsidiary. In some cases of expropriation, some compensation(the amount decided by the host country govt.)is awarded. In other cases, the assets are confiscated and no compensation is provided. Expro.can take place peacefully or by force. The following are the more common forms of political risk:1. Attitude of consumers in the host country 2. Actions of host govt. 3. Blockage of fund transfers 4. Currency inconvertibility 5. War 6. Bureaucracy 7. corruption

COUNTRY RISK ANALYSIS

Country Risk Analysis

Country risk is the potentially adverse impact of a country,s environment on an MNCs cash flows. If the CRA level of a particular country begins to increase, MNC may consider divesting its subsidiaries located there. CRA is not restricted to predicting major crises . An MNC may also use this analysis to refuse its Invt. If financing decisions in light of recent events. In any given week, the follwg unrelated intl events might occur around the world;
A terrorist attack A major labour strike in an industry A political crises due to a scandal within a country A concern abt. Countrys banking system that may cause a major outflow of funds. Any of these events could affect the potential cash flows to be generated by an MNC or the cost of financing projects and therefore, affect the value of the MNC.

Country risk analysis is an ongoing process. Most MNCs will not be affected by every event, but they will pay close attention to any events that may have an impact on the industries or countries in which they do business. They will recognize that they can not eliminate their exposure to all events but may atleast attempt to limit their exposure to any single country-specific event. POLITICAL RISK

FINANCIAL RISK FACTORS

One of the most obvious financial factors is the current and potential state of the countrys economy. An MNC that exports to a country or develops a subsidiary in a country is highly concerned about that countrys demand for its products. This demand is, of course, strongly influenced by the countrys economy. A recession in the country could severely reduce demand for the MNCs exports or products sold by the MNCs local subsidiary. INDICATORS OF ECONOMIC GROWTH:- A countrys economic growth is dependent on several financial factors: INTEREST RATES:- higher interest rates tends to slow the growth of an economy and reduce demand for the MNCs products. Lower interest rates often stimulate the economy and increase demand for the MNCs products.

 EXCHANGE RATES:- exchange rates can influence the demand for the countrys exports, which in turn affects the countrys production and income level. A strong currency may reduce demand for the countrys exports, increase the volume of the products imported by the country, and therefore reduce the countrys production and national income. A very weak currency can cause speculative outflows and reduce the amount of funds available to finance growth by businesses.
INFLATION:- inflation can affect consumers purchasing power and therefore their demand for an MNCs goods. It also indirectly affects a countrys financial condition

COUNTRY RISK ASSESSMENT

There is no census as to how country risk can best be assessed. There are some guidelines for that. The first step is to recognize the difference between MACROASSESSMENT MICROASSESSMENT Macroassessment: it is an overall risk assessment of a country without consideration of the MNCs business Microassessment: The risk assessment of a country as it relates to the MNCs type of business.

MACROASSESSMENT OF COUNTRY RISK

A macroassessment involves consideration of all variables that affect country risk except those unique to a particular firm or industry. This type of assessment is convenient in that it remains the same for a given country, regardless of the firm or industry of concern, however it excludes relevant information that could improve the accuracy of the assessment. Although a macroassessment of country risk is not ideal for any individual MNC, it serves as a foundation that can then be modified to reflect the particular business of the MNC.

MACROASSESSMENT MODEL: Factors to be Assessed

POLITICAL FACTORS: These include the relationship of the host government with MNCs home country govt. the attitude of people in the host country toward MNCs govt. the historical stability of the host govt. the vulnerability of the host govt. to political takeovers and the probability of war between the host country and neighboring countries. Consideration of such political factors will indicate the probability of political events that may affect an MNC and the magnitude of the impact. The september11, 2001 terrorist attack on the US caused more concern about political risk for US based MNC because of all the factors cited here.

 FINANCIAL FACTORS: These factors should include GDP growth, inflation trends, govt. budget levels, interest rates, unemployment, the countrys reliance on export income, balance of trade and foreign exchange controls. The list of these factors could easily be extended.

MICROASSESSMENT OF COUNTRY RISK

While a macroassessment of country risk provides an indication of the countrys overall status, it doesnt assess country risk from the perspective of the particular business concern. A microassessment of country risk is needed to determine how the country risk relates to the specific MNC.

 Example: country Z has been assigned relatively low macroassessment by most of experts due to its poor financial conditions. Two MNCs are deciding whether to set up subsidiaries in country Z. Carco. Inc. is considering developing a subsidiary that would produce automobiles and sell them locally. While Milco. Inc. plans to build a subsidiary that would produce military supplies. Carcos plan to build automobile subsidiary does not appear to be feasible, unless country Z doesnt have sufficient number of automobiles producers already. Country Zs govt. may be committed to purchasing military supplies, regardless of how weak the economy is. Thus, Milcos plan to build a military supplies subsidiary may still be feasible even though country Zs financial condition is poor. It is possible that however country Zs govt. will order its military supplies from a locally owned firm because it wants its supplies to be remained confidential. This possibility is an element of country risk because it is a country characteristic that can affect the feasibility of a project.

 This example illustrates how an appropriate country risk assessment varies with firm, industry and project of concern and therefore why a macroassessment of country risk has its limitations. A microassessment is also necessary when evaluating the country risk related to a particular project proposed by a particular firm. In addition to political variables, financial variables must also be included in a microassessment of country risk. Micro factors include sensitivity of firms business to real GDP growth, inflation trends, interest rates and other factors. In summary overall assessment of country risk includes four parts: MACROPOLITICAL RISK MACROFINANCIAL RISK MICROPOLITICAL RISK MICROFINANCIAL RISK Although these parts can be consolidated to generate a single country risk rating, it may be useful to keep them separate so that an MNC can identify the various ways its direct foreign investment or exporting operations are exposed to country risk.

TECHNIQUES TO ASSESS COUNTRY RISK

That Once a firm identifies all macro and micro factors that deserve consideration in the country risk assessment, it may wish to implement a system for evaluating these factors and determining a country risk rating. Various techniques are available to achieve this objective. Following are some popular techniques:

Checklist Approach Quantitative Analysis

Delphi Technique Inspection visits

Combination of Techniques

CHECKLIST APPROACH
It involves making a judgment on all the political and financial factors that contribute to a firms assessment of country risk. Ratings are assigned to a list of various financial and political factors and these ratings are then consolidated to derive an overall assessment of country risk. Some factors can be measured from available data, while others must be subjectively measured. A substantial amount of information about countries is available on internet. The information can be used to develop ratings of various factors used to assess country risk. The factors are then converted to some numerical ratings in order to assess a particular country. Those factors thought to have a greater influence on country risk should be assigned greater weights. Both the measurement and rating scheme implemented are subjective.

DELPHI TECHNIQUE
It involves collection of various independent opinions without discussion. As applied to country risk analysis the MNC could survey specific employees or outside consultants who have some expertise in assessing a specific countrys risk characteristics. MNC receives responses from its survey and may then attempt to determine some consensus opinions about the perception of the countrys risk. Then it sends it summary of the survey back to the survey respondents and asks for additional feedback regarding its summary of the country risk.

QUANTITATIVE ANALYSIS
Once the financial and political factors have been measured for a period of time, models for quantitative analysis can attempt to identify the characteristics that influence the level of country risk. For e.g. Regression analysis may be used to assess risk, since it can measure the sensitivity of one variable to other variables. A firm could regress its business activity against country characteristics over a series of previous months or quarters. Results from such an analysis will indicate the susceptibility of a particular business to a countrys economy. This is valuable information to incorporate into overall evaluation of country risk. Although quantitative models can quantify impact of variables on each other, they do not necessarily indicate a countrys problems before they actually occur. Nor can they evaluate subjective data that cant be quantified. In addition, historical trends are not always helpful to anticipate upcoming crisis.

INSPECTION VISITS
These involve travelling to a country and meeting with govt. officials, business executives and/ or consumers. Such meetings can help clarify any uncertain opinions the firm has about a country. indeed some variables, such as intercountry relationships may be difficult to assess without a trip to the host country.

COMBINATION OF TECHNIQUES
A survey on 193 corporations heavily involved in foreign business found that about half of them have no formal method of assessing country risk. This doesnt mean that they neglect to assess country risk, but rather there is no proven method to use. So, many MNCs use variety of techniques possibly using check list method to identify relevant factors and then using Delphi technique, quantitative analysis and inspection visits to assign ratings to the various factors.