Chapter Ten

1. Chapter Ten Risk Management and Asset Protection

2. Chapter Objectives • To appreciate the difference between risk and uncertainty • To grasp the idea of managing risk as an opportunity versus risk as a hazard • To learn about foreign exchange risk and the tools that traders and companies use to manage it • To understand the idea of political risk, its principal types, and active versus passive management approaches • To profile competing views of the scope of intellectual property rights • To realize how companies establish and protect intellectual property rights

3. Introduction • FDI, particularly in the economies of emerging markets, offers many opportunities • Sources of risk that especially menace international operations: • Fluctuations in foreign exchange values • Political disruption and turmoil • Intellectual property violations

4. The Idea of Risk Management • The best-laid plans of managers and companies run into challenges when things do not go as planned • Challenges can arise from: • Internal conditions • Abrupt shortage of money to finance expansions • Unforeseen changes in the marketplace • Uncertainty • Comes from changes in economic, social, and political trends • Risk • The chance that a specific company will gain or lose money on a particular investment activity

5. The Idea of Risk Management • The view of risk follows the notion that a basic relationship exists between risk and return • Prudently managed risky markets promise terrific growth opportunities and great profit potential for the confident MNE • Typically, the idea of risk conjures images of negative events such as devastating financial loss • Managing risk as a hazard pushes managers to come up with methods to reduce the odds of a negative event • Globalization steadily pushes firms to see risk more as the price of better opportunities

6. Foreign Exchange Risk • To many, the most striking operating differences between domestic and international business is the financial basis of exchange • Companies try to forecast exchange rate changes in the effort to reduce their possible costs • Companies try to limit the downside of currency fluctuation by: • Modeling currency trends • Forecasting exchange rate movements • Several factors violate the law of supply and demand: • National governments

7. Foreign Exchange Risk • The irony of government intervention in the foreign exchange market is that it is theoretically impossible for any form of intervention to permanently alter the value of a national currency • Government intervention tends to happen in hazardous styles that create extensive foreign exchange risk for international companies • Exchange rate changes can impact: • Marketing decisions • Production decisions • Financial decisions

8. Foreign Exchange Risk • Currency values change frequently • A change in the exchange rate can result in three different exposures for a company • Translation exposure: created by the present measurement of past activity • Transaction exposure: exchange rate fluctuations materially change the expected income from a transaction that is denominated in foreign currency • Economic exposure: materially influence a firm’s future earning power

9. Foreign Exchange Risk • Typically, managers use a mix of the major tools of the foreign exchange market: • Spot exchange rate: the rate at which a foreign exchange market would willingly convert one currency into another currency • Forward exchange rate: governs future deals • Currency swap: refers to the simultaneous purchase and sale of a given amount of foreign exchange for different value dates • Management of economic exposure requires that a company carefully review its idea of risk and assemble the optimum mix of countries within which to build and operate its plants

10. Political Risk • Political risk: the chance that political decisions, events, or conditions in a particular nation will affect the business environment in ways that lead investors to lose some or all of the value of their investment or be forced to accept a lower-than-projected rate of return • There are several types of political risk: • Systemic political risk: generally, the political process within a particular nation does not routinely subject foreign operations to discriminatory treatment • Procedural political risk: can interfere with the process of transactions • Distributive political risk: this form may be subtle • Catastrophic political risk: includes random political developments that adversely affect the operations of companies and MNEs

12. Political Risk • The actions of host governments and local political institutions and actors directly shape the success or failure of overseas operations • Methods of political risk management include: • Active management: depends on identifying the indicators that best measure political risk • Political risk management services • Passive management: treat political risk as an unpredictable hazard of international business and seek ways to hedge their exposure • OPIC • Multilateral development banks (MDBs) • Private insurance

13. Intellectual Property Rights • Intellectual property: the creative ideas, innovative expertise, and intangible insight that gives an individual, company, or country a competitive advantage • Intellectual property rights (IPRs): refers to rights of the registered owner of the particular invention, literary or artistic work, symbol, name, image, or design • World Intellectual Property Organization (WIPO): a United Nations agency established in 1907, administers agreements • A country’s view of IPRs is influenced by: • Level of economic development • National cultural attitudes • Social and economic institutions • Many organizations are trying to set minimum standards for the protection and enforcement of IPRs

15. Intellectual Property Rights • The basis and scope of disagreement among nations on IPRs create fundamental gaps that will not be easily resolved • Companies are trying to devise ways to manage this risk: • Employee relations • Dealing with outside parties • A tough reputation