Country-Level Investment Risks - Term Paper Example

s s of Contents Executive Summary 3 2.Introduction 4 3.Definition 5 4.Types of Ventures 5 5.Risk Rating Mechanisms 6 6.Foreign Exchange Risks 6 7.Financing Mechanisms 7 8.Conclusion 8 Bibliography 8 1. Executive Summary Country risk implies the risk involved in investing in a foreign country where any kind of changes in business environment may alter the course of operating profits or even the value of the owned assets in that country. For instance, a variety of factors contribute in determining whether or not the environment of a country is business friendly. In other words, factors like devaluation of currency, valuation of assets, alongside other financial factors determine stability in the market of a state. Similarly, political factors like protests, civil war, riots and other significant political events contribute towards instability in the market where there is a high country risk in investing in the market. Thus, international companies operating in a state ought to be wary of such factors since the profits and losses are directly correlated to these factors. Therefore, country risk is quite a broad concept where significant research goes into determining methodologies too develop credit ratings to rate various countries based on their risk exposure assessments. These methodologies mostly involve quantitative analysis via econometric models to give an accurate fiscal analysis whereby qualitative analysis is also used to portray the political scenario of a state. Yet, consensus over methodology hasn’t been achieved as yet. For this reason, the paper will aim at analyzing various aspects which may affect country risk i.e. political risks, exchange rate, and interest rate amongst other aspects of the concept to explain their significance. Furthermore, analysis will aim at explaining how home currency may be beneficial along with a theoretical investigation of the concept. 2. Introduction Country risk implies the risk involved in investing in a foreign country where any kind of changes in business environment may alter the course of operating profits or even the value of the owned assets in that country. Country risk is critical in deciding whether or not the country is a safe place to invest in. In other words, factors like devaluation of currency, valuation of assets, alongside other financial factors determine stability in the market of a state. Similarly, political factors like protests, civil war, riots and other significant political events contribute towards instability in the market where there is a high country risk in investing in the market. Thus, international companies operating in a state ought to be wary of such factors since the profits and losses are directly correlated to these factors. (Kosmidou & Doumpos 2008: 8) 3. Definition As explained earlier as well, country risks involve the entire range of risks associated with the idea of investing in a foreign country. These involve a multitude of risks i.e. political risks, exchange rate related risks, sovereign risks, economic risks and even transfer risks (Hoti & MCaleer 2005: 91). The transfer risks here involves the risks involves with the probability of the government freezing up assets or locking up capital aimed at implementation of certain policy initiatives (Rahuma 2012: 16). 4. Types of Ventures Thus, depending on many factors, this risk varies from one state to another, i.e. some countries may have a high risk environment which may be discouraging for foreign investors. Furthermore, investors may choose to invest in a foreign country in a multitude of forms depending on the policies of the home country and the structure and function of the investing company. One of the ways for investing in franchising, and thus a company may lease its name, brand or business model to a company in the host country (Krayenbueh 1985: 22). Franchising may be used as an alternative to chain stores where the investments as well as liability of that chain lies on the company. In this case, the franchiser`s profits are linked to the success of the franchisee directly (Durbin 2013: 14). Secondly, the company may choose to set up a subsidiary (branch) of its original company in the host country i.e. the company would legally still be owned by the parent company with all the functioning being dealt via parent company directly (Foueijieau & Roger 2013: 101-102). Thirdly, a joint venture may also result from a business agreement between the companies in host country and the investor state`s company where both parties contribute equity and have control over enterprise where they share revenues, assets and expenses (Howell 2013: 88-89). Thus, the investors may choose to venture investments in any of the aforementioned ways depending on their priorities and preferences. 5. Risk Rating Mechanisms Furthermore, it is crucial to discuss various aspects of country risk based on which the country risk ratings are determined. Country risk ratings are the standard rates of credit risks for the participant state. Various factors affecting the investing environment of a state a rated based on a set methodology against fiscal as well as other similar indicators to generically state the visibility of risk in that particular state with reference to investors (Political risk services 2002: 18). The risk projections take into account the participant country`s risks as well as government failures, successes, flexibility in policy implementation, and also, other factors, based on which credit rating is determined and all states are rated against the standard credit rating (Crowther & Aryas 2013:101). In this context, as mentioned earlier as well, political risks are the most significant which assess the risks faced by the corporations due to government policies and political environment in the state. Such a risk can be managed via enhanced investment as well as with reasoned foresight on part of government to encourage foreign investment. Also, political risks may include complications which the businesses may have to face as a result of political results or economic policy outcomes of a county. Thus, non-markets factors contribute towards alteration in the market forces, and such non-market factors are usually the political risks (Jensen 2012: 43). Furthermore, other kinds of risks must also be taken into account. 6. Foreign Exchange Risks In addition to political risks, foreign exchange risks are also significance; since these involve financial transactions affected by currency of the state, other than the base currency of the company. Such a risk may also be endured when a foreign subsidiary maintains the financial statements in the form of currency not compliant to the currency of the reporting consolidated entity. In such a scenario, an adverse movement may be observed in the exchange rate of denomination currency in comparison to the rate of currency on the date when the transaction was processed. Thus, companies are often wary of such a risk. Similarly, interest rates may also pose another risk for the investing companies. International Fisher Effect also known as IFE may be appropriate here which analyzes present as well as future nominal interest rates, irrespective of pure inflation modalities. This model is helpful in predicting the future movements of the currency, which in turn affects helps the investors in realizing the risk free scenarios of free flow of capital between states. Thus broad range projections are made, based on the general financial risks, political risks, foreign exchange risks, inflation related risks along with other factors, based on which credit rating is allotted to various states to reflect the business environment in these respective states. (Araya, Schwartz & Andres 2013: 14-15) 7. Financing Mechanisms In this context, it must also be understood how states are financed. Financing is progressed via traditional ways even in this era owing to the increased amount of volatility in the financial markets, along with issues like global depression and euro crisis (Country Risk Service 2000: 2). Thus, in this scenario, the traditional way is to focus on the internal financing dynamics emerging from the internal cash-flows of the companies. Furthermore, international institutions like the International Financial Corporation (IFC) also facilitate financing by implicating conditionalities and facilitating alliances of borrowing companies with financing ones. Thus, the borrower states are at an advantage if their credit ratings are favorable i.e. the country risk is low (Bouchet & Clarke 2003: 9). In this context, states including Norway, Switzerland, Singapore, Luxemberg, Sweeden. Denmark, Finland, Netherlands, Canada and Australia are the least risky states (Painter 2013: 66). However, foreign direct investment may also result in risky states as well, depending on the economic ties of the states and the priorities of the investors. Currently, United States and China top the list of host countries offering foreign direct investment in host companies, thus, states looking for FDI must look up to these states to acquire financing (World Bank 2013: 11-12). However, home currency also has its own advantages for investors especially since the taxed would be lower and revenues would thus be high. This would also allow diversification in investment which is also crucial to success of a company given the high competition in the global market (Handbook of country risk 2008:81). Thus, financing is yet another aspect attached to the concept of country risk and thus, various options must be explored in this regard. 8. Conclusion Thus, conclusively, country risk is the study or the assessment of risks involved in a country in context to the investment environment. The investors ought to enhance their profits and thus, they prefer investing in a country where risk factors aren’t too high. The Utility theory must be mentioned in this regards as it stresses on the significance of consumer satisfaction while consumption of a good which is the measure of the utility of the product being sold (Tapiero 2013: 12). Thus, the entire market is based on the utility of the products and services, and thus, it drives the market forces in such a way that investors are naturally drawn in a country where the utility of their products is high. Thus, international markets may prove to be a wide market for products of a company. However, country risk is critical in deciding whether or not the country is a safe place to invest in. In other words, factors like devaluation of currency, valuation of assets, alongside other financial factors determine stability in the market of a state. Similarly, political factors like protests, civil war, riots and other significant political events contribute towards instability in the market where there is a high country risk in investing in the market. Thus, international companies operating in a state ought to be wary of such factors since the profits and losses are directly correlated to these factors. 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