Fundamentals of Multinational Finance, 6e (Moffett et al.)
Chapter 17 Foreign Direct Investment and Political Risk
17.1 The Foreign Direct Investment Decision
1) An example of economies of scale in financing include:
A) being able to access the Euroequity, Eurobond, and Eurocurrency markets.
B) being able to ship product in shiploads or carloads.
C) being able to use large-scale plant and equipment.
D) all of the above
2) Based on observations of firms that have successfully invested abroad, we can conclude that
one of the competitive advantages enjoyed by MNEs is:
A) managerial expertise.
B) financial strength.
C) competitiveness of their home markets.
D) all of the above are competitive advantages.
3) Based on observations of firms that have successfully invested abroad, we can conclude
companies are more competitive when:
A) facing sophisticated and demanding customers in the home market.
B) surrounded by a critical mass of related industries and suppliers.
C) located in countries that are naturally endowed with the appropriate factors of production.
D) All of the above are true.
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4) The OLI paradigm is an attempt to create a framework to explain why MNEs choose
________ rather than some other form of international venture.
A) licensing
B) joint ventures
C) foreign direct investment
D) strategic alliances
5) The O in OLI refers to an advantage in a firm’s home market that is:
A) operator independent.
B) owner-specific.
C) open-market.
D) official designation.
6) The owner-specific advantages of OLI must be:
A) firm-specific.
B) not easily copied.
C) transferable to foreign subsidiaries.
D) all of the above
7) A/An ________ would be an example of an owner-specific advantage for an MNE.
A) patent
B) economy of scale
C) economy of scope
D) all of the above
8) The L in OLI refers to an advantage in a firm’s home market that is a:
A) liability in the domestic market.
B) location-specific advantage.
C) longevity in a particular market.
D) none of the above
9) A/An ________ would be an example of a location-specific advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information
10) The I in OLI refers to an advantage in a firm’s home market that is an:
A) internalization.
B) industry-specific advantage.
C) international abnormality.
D) none of the above
11) A/An ________ would be an example of an internalization advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information
12) In deciding whether to invest abroad, management must first determine whether the firm has
a sustainable competitive advantage that enables it to compete effectively in the home market.
The competitive advantage must be:
A) firm specific.
B) not easily copied.
C) in a transferable form.
D) all of the above
13) Which of the following is NOT a market imperfection or genuine comparative advantage that
attracts FDI to particular locations?
A) low cost and productive labor force.
B) unique sources of raw materials.
C) defensive investments.
D) an expansive monetary policy.
14) MNEs that are resident in liquid and unsegmented capital markets are more likely to be able
to demonstrate financial strength by achieving and maintaining a global cost and availability of
capital.
15) A strongly competitive home market tends to dull the competitive advantage relative to firms
located in less competitive home markets.
16) The authors were unable to identify in lesser developed countries specific firms that are
nearing the status of global MNE.
17) Small- and medium-size firms often attract foreign investors and achieve a global cost of
capital.
18) Reactive financial strategies can be formulated in advance by the MNE’s financial managers.
19) Proactive financial strategies depend on discovering market imperfections.
20) What does the OLI Paradigm propose to explain? Define each component and provide an
example of each.
21) List and explain three strategic motives why firms become multinationals and give an
example of each.
1) Which of the following is NOT true regarding behavioral observations of firms making a
decision to invest internationally?
A) MNEs initially invest in countries with a similar “national psychic.”
B) Firms eventually take greater risks in terms of the national psychic of countries in which they
invest.
C) Initial investments tend to be much larger than subsequent ones.
D) All of the above have been observed.
2) Which of the following is NOT an advantage to exporting goods to reach international
markets rather than entering into some form of FDI?
A) fewer political risks
B) greater agency costs
C) lower front-end investment
D) All of the above are advantages.
3) Which of the following is an advantage to exporting goods to reach international markets
rather than entering into some form of FDI?
A) fewer agency costs
B) fewer direct advantages from research and development
C) a greater risk of losing markets to copycat goods producers
D) an inability to exploit R&D as effectively as if also invested abroad
4) Which of the following is NOT a form of FDI?
A) wholly-owned affiliate
B) joint venture
C) exporting
D) greenfield investment
5) With licensing the ________ is likely to be lower than with FDI because of lower profits;
however, the ________ is likely to be higher due to a greater return per dollar invested.
A) IRR; NPV
B) NPV; IRR
C) cost of capital; NPV
D) IRR; cost of capital
6) Which of the following is NOT a potential disadvantage of licensing relative to FDI?
A) possible loss of quality control
B) establishment of a potential competitor in third-country markets
C) possible improvement of the technology by the local licensee, which then enters the original
firm’s home market
D) All of the above are potential disadvantages to licensing.
7) A ________ is a shared ownership in a foreign business.
A) licensing agreement
B) greenfield investment
C) joint venture
D) wholly-owned affiliate
8) Which of the following is NOT an advantage to a joint venture?
A) Possible loss of opportunity to enter the foreign market with FDI later.
B) The local partner understands the customs and mores of the foreign market.
C) The local partner can provide competent management at many levels.
D) May be a realistic alternative when 100% foreign ownership is not allowed.
9) Greenfield investments are typically ________ and ________ than cross-border acquisition.
A) slower; more uncertain
B) faster; of greater certainty
C) slower; of greater certainty
D) faster; more uncertain
10) All of the following may be justification for a strategic alliance EXCEPT:
A) takeover defense
B) a joint venture to pool resources for research and development
C) joint marketing and serving agreements
D) All of the above are legitimate reasons for strategic alliances
11) In practice, when expanding into other countries, firms have been observed to follow a
sequential search pattern as described in the behavioral theory of the firm.
12) As a general rule, the decision about where to invest abroad for the first time is the same as
the decision about where to reinvest abroad.
13) Economists have observed that firms tend to invest first in countries that are too far distant in
psychic distance (similar cultural, legal, and institutional environment).
14) Transnationals are firms that have operations in more than one country and conduct their
business through branches, foreign subsidiaries, or joint ventures with host country firms.
15) Licensing is a popular form of foreign investment because it does not need a sizable
commitment of funds, and political risk is often minimized.
16) MNEs typically used licensing with independent firms rather than with their own foreign
subsidiaries.
17) Joint ventures are a more common FDI than wholly owned subsidiaries.
18) Local partners in a foreign country and in a joint venture with an MNE are likely to make
decisions that maximize the value of the subsidiary. Such actions probably will not maximize the
value of the entire firm.
19) What are the advantages and disadvantages of serving a foreign market through a greenfield
foreign direct investment compared to an acquisition of a local firm in the target market?
20) The decision about where to invest abroad is influenced by behavioral factors. Explain the
behavioral approach to FDI.
17.3 Political Risk: Definition and Classification
1) ________ 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
2) 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.
3) According to your authors, MNEs can anticipate government regulations that are
discriminatory or wealth depriving from a/an ________ or ________ level view.
A) foreign; domestic
B) micro; macro
C) internal; external
D) local; global
4) ________ 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
5) 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.
6) 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.
7) ________ is a type of political risk that OPIC does NOT cover.
A) Inconvertibility
B) Expropriation
C) War
D) OPIC covers all of the above.
8) ________ 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
9) ________ 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
10) 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
11) Terrorism, cyber attacks, and the anti-globalization movement are each examples of
________ risks.
A) firm-specific
B) country-specific
C) institutional
D) global-specific
12) 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) minimizing 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
13) A number of institutional services provide updated country risk ratings on a regular basis.
This is an example of micro-risk information for MNEs using this data.
14) Business risk can be measured through sensitivity analysis but from only the project
viewpoint.
15) 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.
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16) What are the main types of political risks that are global in origin? What are the main
strategies used by MNEs to manage the globalspecific risks you have identified?
17) What is meant by the term “governance risk”? What is the most important type of
governance risk?
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18) An investment agreement spells out specific rights and responsibilities of both the foreign
firm and the host government. What are the main financial policies that should be included in an
investment agreement?
1) This section does not contain any questions.
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17.5 Political Risk Mitigation
1) 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
2) Which of the following is NOT one of the stages at which MNEs can react to the potential for
blocked funds?
A) prior to investing
B) during operations
C) reinvesting in the local country when funds cannot be moved
D) All of the above are stages at which MNEs can react.
3) 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
4) 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.
5) 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
6) 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.
7) 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.
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8) What are blocked funds? List and explain two of the three methods the authors list in this
chapter for dealing with blocked funds.