Explain how political risk increase the uncertainty of international projects for the purpose of multinational capital budgeting.
Political risk is the risk that a government action will negatively affect a company’s cash flows. In the most extreme form of political risk, governments seize property without compensating the owners in a total expropriation (or nationalization). Country risk is a broader concept that encompasses both the potentially adverse effects of a country’s political environment and its economic and financial environment. For example, a recession in a country that lowers its aggregate demand and reduces the revenues of exporters to that nation is a realization of country risk. Labor strikes by a country’s dockworkers, truckers, and transit workers that disrupt production and distribution of products, thus lowering profits, also qualify as country risks. Clashes between rival ethnic or religious groups that prevent people in a country from shopping can also be considered country risks. In international bond markets, country risk refers to any factor related to a country that can cause a borrower to default on a loan. When country risk is taken in a narrow sense to be the risk associated with a government defaulting on its bond payments, it is called sovereign risk.
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