554 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management
17-10 INVESTING OVERSEAS
Investors should consider additional risk factors if they invest overseas. First, there
is country risk, which refers to the risk involved in investing in a particular coun-
try. This risk depends on the country’s economic, political, and social environ-
ment. Some countries provide a safer investment climate and therefore less country
risk than others. Examples of country risk include the risk that property will be
expropriated without adequate compensation in addition to risks associated with
changes in tax rates, regulations, and currency repatriation. Country risk also
includes changes in host-country requirements regarding local production and
employment as well as the danger of damage due to internal strife, ranging from
crippling strikes to terrorism and civil war.
It is especially important to keep in mind when investing overseas that securi-
ties are often denominated in a currency other than the dollar, which means that
returns on the investment depend on what happens to exchange rates. This is
known as exchange rate risk. For example, if a U.S. investor purchases a Japanese
bond, interest will probably be paid in yen, which must then be converted into
dollars before the investor can spend his or her money in the United States. If the
yen weakens relative to the dollar, it will buy fewer dollars; hence, fewer dollars
will be received when funds are repatriated. However, if the yen strengthens, the
effective investment return will increase. It therefore follows that returns on a for-
eign investment depend on the in-country performance of the foreign security and
on changes in exchange rates.Country Risk
The risk that arises from
investing or doing business
in a particular country.
Country Risk
The risk that arises from
investing or doing business
in a particular country.
Exchange Rate Risk
The risk that exchange rate
changes will reduce the
number of dollars
provided by a given
amount of a foreign
currency.
Exchange Rate Risk
The risk that exchange rate
changes will reduce the
number of dollars
provided by a given
amount of a foreign
currency.
SELF^ TEST What are the three major types of international credit markets?
What is LIBOR?
What are ADRs?SELF^ TEST What is country risk?
What is exchange rate risk?
On what two factors does the return on a foreign investment depend?listed in the United States—one example is Royal Dutch Petroleum, which is listed
on the NYSE. U.S. investors also can invest in foreign companies through American
Depository Receipts (ADRs), which are certi! cates representing ownership of for-
eign stock held in trust. About 1,700 ADRs are now available in the United States,
with most of them traded on the over-the-counter (OTC) market. However, more
and more ADRs are being listed on the New York Stock Exchange, including
England’s British Airways, Japan’s Honda Motors, and Italy’s Fiat Group.American Depository
Receipts (ADRs)
Certificates representing
ownership of foreign stock
held in trust.American Depository
Receipts (ADRs)
Certificates representing
ownership of foreign stock
held in trust.