Chapter 14: Political and Country Risk
Power Points created by:
Joseph F. Greco Ph. D.
California State University, Fullerton
Mihaylo College of Business and Economics
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Chapter 14: Political and Country Risk
14.1
Political Risk Versus Country Risk
14.2
Incorporating Political Risk in Capital Budgeting
14.3
Country and Political Risk Analysis
14.4
Managing Political Risk
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14.1 Political Risk Versus Country Risk
• Country Risk
• Sovereign risk
• Financial and economic risk factors
• Industry factors and country risk
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14.1 Political Risk Versus Country Risk
• Political Risk Factors
• Expropriation or nationalization
• Contract repudiation
• Taxes and regulation
• Exchange controls
• Corruption and legal inefficiency
• Ethnic violence, political unrest, and terrorism
• Home-country restriction
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Exhibit 14.1
Legal System Quality
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14.1 Political Risk Versus Country Risk
• The Debt Crisis
• Origins of the debt crisis
• Managing the debt crisis
• The Baker plan
• Debt and debt service-reducing operations
• Debt buyback
• Debt-equity swap
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Exhibit 14.2
The Origins of the
Debt Crisis
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14.1Political Risk Versus Country Risk
• The Brady Plan
– Options available to the banks:
•
•
•
•
Buybacks
Discount bond exchange
Par bond exchange
Conversion bonds combined with new money
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14.2 Incorporating Political Risk in Capital
Budgeting
• Adjusting Expected Cash Flows for Political Risk
• Adjusting the Discount Rate Instead of Cash Flows
• Discount rates for emerging markets and political
risk
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Exhibit 14.3
Adjusting the MNC’s Cash Flows for Political Risk
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14.3 Country and Political Risk Analysis
Country and Political Risk Analysis: Overview
• Country Risk Ratings
• The PRS Group’s ICRG Rating System
• Country Credit Spreads
• Computing Political Risk Probabilities
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14.3 Country and Political Risk Analysis
• Country Risk Ratings
• Political risk analysis
• Institutional investor
• Economist intelligence unit
• Other ratings systems
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Exhibit 14.4
Risk Attributes and Political Risk Analysis
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14.3 Country and Political Risk Analysis
• The PRS Group’s ICRG Rating System
• Financial and economic risk factors
• The political risk components
• Overall ratings
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Exhibit 14.5
The ICRG Risk
Components
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Exhibit 14.6
Country and Political Risk Ratings for Selected Countries
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14.3 Country and Political Risk Analysis
• Country Credit Spreads
• Sovereign credit ratings
• Why is sovereign credit risk different?
• Country spreads and political risk probabilities
• Default probabilities with positive recovery values
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Exhibit 14.7
Sovereign Credit Ratings by Fitch
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14.3 Country and Political Risk Analysis
• Taking Governments to Court
• Bilateral investment treaties (BITs)
• International Center for the Settlement of
Investment Disputes (ICSID)
– Historical Background: Brady Bounds
– Analyzing a Brady Bond
– Country spreads and political risk probabilities
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Exhibit 14.8
Analyzing a Brady Bond
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Exhibit 14.9
Country and Currency Premiums around the Mexican
Currency Crisis
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14.3 Country and Political Risk Analysis
• Computing Political Risk Probabilities
• Using country spreads to compute political risk
probabilities
• Using political risk ratings
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14.4 Managing Political Risk
Managing Political Risk: Overview
• Structuring an Investment
• Insurance
• Project Finance
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14.4 Managing Political Risk
• Structuring an Investment
• Focus on the short term
• Rely on unique supplies or technology
• Use local resources
• Bargain with the government
• Hire protection
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14.4 Managing Political Risk
• Insurance
• Political risk insurance for U.S. Companies
• Overseas private investment corporation
(OPIC)
• Political risk insurance in emerging and
transitioning economy
• Multilateral investment guarantee agency
(MIGA)
• Public versus private insurance
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Exhibit 14.10
Political Risk Insurance and Capital Budgeting
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14.4 Managing Political Risk
• Project Finance
• Two Main Characteristics:
• The financing is project specific
• The return to fund providers is primarily
generated by the project
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