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Fundamentals of Multinational Finance, 3e (Moffett)

Chapter 18 Political Risk Assessment and Management


18.1 Multiple Choice and True/False Questions
1) The possibility of suffering harm or loss, or a course involving uncertain danger or hazard is
a definition of ________.
A) risk
B) standard deviation
C) beta
D) variance
Answer: A
Topic: Risk
Skill: Recognition

2) Which of the following is NOT an example of a subjective measure gathered by institutional


researchers?
A) a local country's ranking for political stability
B) a local country's ranking for economic stability
C) a local country's unemployment rate
D) All of the above are subjective measures.
Answer: C
Topic: Subjective Measures of International Risk
Skill: Recognition

3) Of the following, which would NOT be considered a firm-specific risk?


A) the risk of getting new management
B) management policies toward hedging foreign exchange risk
C) parent company policy toward management of local subsidiaries
D) All could be considered firm-specific risk.
Answer: D
Topic: Firm-specific Risk
Skill: Recognition

4) ________ risks are those that affect the MNE at the local or project level, but originate at the
country level.
A) Country-specific
B) Firm-specific
C) Global-specific
D) None of the above
Answer: A
Topic: Country-specific Risk
Skill: Recognition

5) Which of the following is NOT an example of a country-specific risk?


A) transfer risk
B) war and ethnic strife
C) cultural and religious heritage
D) All of the above are examples of country-specific risk.
Answer: D
Topic: Country-specific Risk
Skill: Recognition

6) Which of the following is NOT a strategy to measure and manage foreign investment risks?
A) sensitivity analysis
B) diversification
C) insurance
D) All are strategies to measure and manage foreign investment risk.
Answer: D
Topic: Foreign Investment Risk
Skill: Recognition

7) When faced with additional risk from a foreign investment, firms typically account for the
additional risk by adjusting the discount rates or by adjusting cash flows.
Answer: TRUE
Topic: Risk-adjusted Cash Flows
Skill: Conceptual

8) Which of the following would be a shortcoming of adjusting discount rates to account for
the increased risk of foreign investments?
A) The actual size of the cash inflows may vary from the expected values.
B) The timing of the cash flows are unknown.
C) Treating the uncertain cash flows as if they were one-sided risks rather than two-sided
risks.
D) None of the above.
Answer: C
Topic: Risk-adjusted Discount Rates
Skill: Conceptual

9) Adjusting the discount rate to account for increased political risk is almost always the best
possible way to account for risk.
Answer: FALSE
Topic: Risk-adjusted Discount Rates
Skill: Conceptual

10) ________ is the ability to exercise effective control over a foreign subsidiary within a
country's legal and political environment.
A) Political risk
B) Portfolio risk
C) Interest rate risk
D) Governance risk
Answer: D
Topic: Governance Risk
Skill: Recognition

11) Of the following, which would NOT be considered an issue for an investment agreement
prior to investing in a foreign country?
A) the basis for setting transfer prices
B) the right to export to third-country markets
C) provision for arbitration of disputes
D) All of the above could be negotiated prior to investing.
Answer: D
Topic: Pre-investment Negotiations
Skill: Conceptual

12) OPIC stands for


A) Organization for the Prevention of Insufficient Capitalization.
B) Organization of Petroleum Importing Countries.
C) Overseas Private Investment Corporation.
D) Overseas Public Insurance Commission.
Answer: C
Topic: OPIC
Skill: Recognition

13) ________ is a type of political risk that OPIC does NOT cover.
A) Inconvertibility
B) Expropriation
C) War
D) OPIC covers all of the above.
Answer: D
Topic: OPIC
Skill: Recognition

14) ________ is the risk that the investor will not be able to convert profits, royalties, or fees into
dollars.
A) Inconvertibility
B) Expropriation
C) Business income risk
D) None of the above
Answer: A
Topic: Inconvertibility
Skill: Recognition

15) ________ is the risk that the host government will take specific steps that prevent the foreign
affiliate from exercising control over the firm's assets.
A) Inconvertibility
B) Expropriation
C) Business income risk
D) None of the above
Answer: B
Topic: Expropriation
Skill: Recognition

16) FDI may require firms to be flexible in how they do business. Which of the following is NOT
a potential problem associated with a firm adapting to a government requirement of local
sourcing?
A) a lack of local economies of scale to produce needed raw materials
B) unreliable delivery schedules on the part of local firms
C) uncertain quality control
D) All of the above are potential forced local sourcing problems.
Answer: D
Topic: FDI Flexibility
Skill: Conceptual

17) ________ is NOT one of the three main country-specific risks as outlined by your authors.
A) Transfer risk
B) Cultural differences
C) Thin equity base
D) Protectionism
Answer: C
Topic: Country-specific Risk
Skill: Recognition

18) A country can react to the potential for blocked funds prior to making an investment, during
operations, or by investing in the local country in assets than maintain their value.
Answer: TRUE
Topic: Blocked Funds
Skill: Conceptual

19) An FDI project that enters a country for the purpose of constructing an assembly facility for
products that are to be re-exported is an example of ________.
A) resource seeking behavior
B) market seeking behavior
C) production seeking behavior
D) labor seeking behavior
Answer: C
Topic: Production-seeking Behavior
Skill: Conceptual

20) Blocked funds are cash flows that


A) come in regular intervals in standardized amounts or blocks.
B) have been restricted in transfer out of a local country.
C) come from a certain sector or region of the world.
D) none of the above.
Answer: B
Topic: Blocked Funds
Skill: Recognition

21) A ________ loan, also known as ________ is a parent-to-affiliate loan channeled through a
financial intermediary such as a large commercial bank.
A) fronting; link financing
B) parallel; a back-to-back loan
C) fronting; a back-to-back loan
D) link financing; parallel loan
Answer: A
Topic: Fronting Loans
Skill: Recognition

22) Which of the following is NOT a typical characteristic of a fronting loan made to an
international subsidiary?
A) The parent makes a deposit equal to the size of the desired loan into a large commercial
bank.
B) The bank lends to the subsidiary firm an amount equal to the parent deposit at a
slightly higher interest rate.
C) The lending bank is located in the subsidiary's country.
D) All of the above are typical characteristics of a fronting loan.
Answer: C
Topic: Fronting Loans
Skill: Recognition

23) Banks are very hesitant to engage in fronting loans because of the low probability of
repayment and thus their risk exposure up to a 100% loss.
Answer: FALSE
Topic: Fronting Loans
Skill: Conceptual

24) Government authorities are more likely to allow subsidiary repayment of a loan to a large
international bank than to a parent firm because
A) stopping payment to an international bank would have a negative impact on the credit
image of the country.
B) the government is also borrowing money from that bank and wants a larger loan
before they choose to default.
C) corrupt government officials have accounts at the bank and they have made an underthe-table agreement not to withhold funds from that bank.
D) none of the above are true.
Answer: A
Topic: Fronting Loans
Skill: Recognition

25) Which of the following is NOT a technique for moving blocked funds out of a country?
A) use fronting loans
B) create unrelated exports
C) obtain a special dispensation
D) All of the above are techniques for moving blocked funds.
Answer: D
Topic: Blocked Funds
Skill: Recognition

26) Which of the following could be considered an example of forced reinvestment if the
blockage of funds was expected to be temporary?
A) vertical reinvestment by an automobile manufacturer to buy parts suppliers and
showrooms
B) a lumber cutting company subsequently builds a paper mill with blocked funds
C) purchase of local money market instruments and short-term loans
D) all of the above
Answer: C
Topic: Blocked Funds
Skill: Conceptual

27) Sovereign risk is the danger


A) that the country's royalty will be overthrown in a military coup.
B) that a country will need to pay a risk premium to investors in order to raise funds at
home or abroad.
C) that country's royal family is unfit to rule.
D) none of the above.
Answer: B
Topic: Sovereign Risk
Skill: Recognition

28) Of the following, which was NOT identified by the authors as a type of cultural difference
that MNEs must consider when expanding to foreign countries?
A) differences in human resource norms
B) differences in religious heritage
C) differences in allowable ownership structures
D) All of the above must be considered.
Answer: D
Topic: Cultural Differences
Skill: Recognition

29) The Scandinavian countries such as Denmark, Finland, and Sweden, are perceived as having
the lowest level of corruption in the world.
Answer: TRUE
Topic: Corruption Levels
Skill: Recognition

30) A foreign investment undertaken by an MNE that is considered risky from a political and
currency perspective may still be undertaken because:
A) The investor is forming a strategic alliance with a domestic partner.
B) The MNE is basing its foreign investment decisions on a portfolio basis.
C) The MNEs management does not believe that risk can be measured or predicted.
D) The investor knows that they will be more than adequately compensate for accepting
higher risk.
Answer: B
Topic: Investment Portfolio
Skill: Conceptual

31) ________ is an acceptable method of adjusting for risk when analyzing the prospects of a
foreign investment.
A) Adjusting the discount rate
B) Adjusting the cash flows
C) Conducting sensitively and scenarios analysis
D) All of the above
Answer: D
Topic: Methods of Risk Adjustment
Skill: Conceptual

32) The U.S. Treasury bond is considered to be a "risk-free" security because the payment of
principal and interest
A) will be adjusted for inflation.
B) will be adjusted for changes in the U.S. dollar's yield curve.
C) will be paid because the U.S. government has the ability to create money to repay
bondholders.
D) all of the above are true.
Answer: C
Topic: Risk-free Return
Skill: Conceptual

33) An alternative strategy to engaging in bribery in international investments include:


A) Refuse bribery outright.
B) Retain local advisors to diffuse requests for bribes.
C) Educate management and local employees about the firm's bribery policy.
D) All of the above.
Answer: D
Topic: Bribery
Skill: Recognition

34) ________ industries are NOT typically "protected" by government policy.


A) Textiles
B) Defense
C) Agriculture
D) "Infant" industries
Answer: A
Topic: Protectionism
Skill: Recognition

35) Forming regional alliances is one way to help mitigate the practice of government
protectionism. Which of the following is NOT a regional trade organization formed by
government treaty?
A) EU
B) NAFTA
C) NATO
D) MERCOSUR
Answer: C
Topic: International Trade Organizations
Skill: Recognition

36) Which of the following are NOT among the leaders in the world's anti-globalization
movement?
A) MNEs
B) environmentalists
C) unions whose workers lose jobs as a result of trade pacts such as NAFTA
D) those opposed to the loss of cultural identity due to combinations such as the European
Union
Answer: A
Topic: Anti-globalization Movements
Skill: Recognition

37) As of 2007, the United States government has been a willing participant and co-sponsor of
international treaties to reduce pollution worldwide.
Answer: FALSE
Topic: Anti-pollution Treaties
Skill: Conceptual

38) Many problems such as poverty, environmental concerns, and cyber attacks are beyond the
capabilities of MNEs alone to correct and require government participation as well.
Answer: TRUE
Topic: Social Issues
Skill: Conceptual

39) Business risk can be measured through sensitivity analysis but from only the project
viewpoint.
Answer: FALSE
Topic: Business Risk
Skill: Conceptual

40) ________, also known as micro risks, are political risks that affect the MNE at the project and
corporate level but do not originate at the country level.
A) Firm-specific risks
B) Country-specific risks
C) Global-specific risks
D) Transfer risks
Answer: A
Topic: Firm-specific Risk
Skill: Recognition

41) ________, also known as macro risks, are political risks that affect the firm at the project or
corporate level but originate at the country level.
A) Firm-specific risks
B) Country-specific risks
C) Global-specific risks
D) Governance risks
Answer: B
Topic: Country-specific Risk
Skill: Recognition

42) Terrorism, cyber attacks, and the anti-globalization movement are each examples of
________ risks.
A) firm-specific
B) country-specific
C) institutional
D) global-specific
Answer: D
Topic: Global-specific Risk
Skill: Recognition

43) Governance risk due to goal conflict between an MNE and its host government is the main
political ________ risk.
A) firm-specific
B) country-specific
C) global-specific
D) cultural-specific
Answer: A
Topic: Governance Risk
Skill: Recognition

44) Transfer risk concerns mainly the problem of ________.


A) governance risk
B) cultural risk
C) blocked funds
D) environmental concerns
Answer: C
Topic: Transfer Risk
Skill: Recognition

45) Macro political risk analysis is likely to include all but which of the following?
A) analysis of a country's historical stability
B) evidence of present turmoil or dissatisfaction with the current government
C) indications of economic stability or instability
D) All of the above are likely to be included in a macro political analysis.
Answer: D
Topic: Macro Political Risk
Skill: Recognition

46) According to surveys reported in March 2007, which country had the highest value (least
risk) on a country-wide economic risk scale?
A) Indonesia
B) Brazil
C) Finland
D) Russia
Answer: C
Topic: Country Economic Risk
Skill: Recognition

47) Negotiations under the General Agreement on Tariffs and Trade (GATT) have NOT had
much impact on reducing the level of tariffs over the last several decades.
Answer: FALSE
Topic: GATT
Skill: Conceptual

48) Which of the following would NOT be considered a non-tariff barrier to trade?
A) inconsistent customs and administrative entry procedures
B) unduly stringent or discriminating standards imposed on imports in the name of
protecting health, safety, and quality
C) established import procedures that make importing more difficult
D) All of the above are non-tariff trade barriers.
Answer: D
Topic: Non-tariff Trade Barriers
Skill: Conceptual

49) Which of the following is NOT an established regional market designed in part to reduce
protectionism and trade barriers among members?
A) The European Union
B) NAFTA
C) MERCOSUR
D) All are regional markets.
Answer: D
Topic: Regional Markets
Skill: Recognition

50) The speed at which inventory moves through a manufacturing process is known as
________.
A) supply chain management
B) working capital management
C) inventory velocity
D) warp speed
Answer: C
Topic: Inventory Control
Skill: Recognition

51) As a result of the terrorist attacks of September 11, 2001, many firms have employed a wide
range of tactics to ensure continued flow of inventory in the face of government steps to curb
terrorism. Which of the following is an inventory sourcing strategy response (as opposed to
an inventory management response, or a transportation response)?
A) carrying more inventory on-hand
B) minimize cross-border exposure from suppliers
C) shifting to air cargo shipments instead of co-habitation of products and passengers on
commercial air flights
D) increasing the on-hand supply of critical parts
Answer: B
Topic: Inventory Control
Skill: Conceptual

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52) Over the last three decades, the country of Zimbabwe has suffered ________.
A) hyperinflation
B) hyperunemployment
C) a drastic reduction in life expectancy
D) all of the above
Answer: D
Topic: Zimbabwe
Skill: Recognition

53) Zimbabwe ranks 150th on the 2007 Corruption Perception Index. Thus, despite the country's
economic woes, it still perceived as having low levels of government corruption.
Answer: FALSE
Topic: Zimbabwe
Skill: Recognition

54) The USA has a value of 7.4 on the 2007 Corruption Perception Index. Although this value
does not put the USA at the top of the list, the USA is still perceived as one of the ________
least corrupt countries in the world in which to do business.
A) 5
B) 10
C) 15
D) 20
Answer: D
Topic: Corruption Levels
Skill: Recognition

18.2 Essay Questions


1) Generally, firms adjust for the additional risk from investing in foreign locations using one
of two techniques. List and explain the two techniques, cite advantages and disadvantages of
each, and provide an example of when each might be most appropriate.
Answer: Risk is generally accounted for by developing risk-adjusted cash flows, or by using a
risk-adjusted discount rate. Risk-adjusted cash flows would consider the techniques
we use in domestic capital budgeting, but then also consider the variability that could
be brought on by changing exchange rates, temporary blockage of funds, uncertain
demand in foreign markets that consume your service or products, and other various
forms of political risk.
A risk-adjusted discount rate attempts to account for the additional risks just
mentioned above, but it adjusts the expected cash flows by increasing the discount
rate for greater risk, and lowering the discount rate for less risk according to
requirements in the market.
Both techniques have fault. As the authors state, adjusting expected cash
flows or the rate at which they are discounted may be appropriate for those cash
flows, but do not account for the entire risk to the firm implied by political risk and
expropriation of the firm itself instead of just a few cash flows. Furthermore, adjusting
the discount rate may be appropriate for only a portion of the time period under
consideration.

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2) What are blocked funds? List and explain two of the three methods the authors list in this
chapter for dealing with blocked funds.
Answer: Blocked funds are those that have been restricted from foreign exchange in some
fashion by the government of the host country. If this is a potential problems firms
take a number of steps to reduce or minimize the impact of such a governmental
action. In this chapter the authors identify three techniques for dealing with the
problem of blocked funds. First, using fronting loans. Here the firm deposits money
into a large financial institution, typically in a neutral third country, and then has the
bank loan the same amount to the foreign subsidiary. There are several reasons why
governments are more likely to allow repayments of such loans as opposed to
repayment to the parent.
Second, the local firm may create new exports thus increasing the flow of
currency into the country and achieving the goals of the government. Third, the
authors also mention a special dispensation whereby firms in highly desirable and
specialized industries such as telecommunications or pharmaceuticals are
contractually guaranteed repatriation of funds at a greater rate than normal.

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