Deck 17: Foreign Direct Investment and Political Risk

Question 1

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

Answer 1

foreign direct investment

Question 2

What does the OLI Paradigm propose to explain? Define each component and provide an example of each.

Answer 2

The OLI Paradigm is an attempt to develop an overall framework to explain why MNEs choose FDI to serve foreign markets rather than alternatives such as licensing or exporting. The letters of the paradigm are O for owner-specific advantages, L for location-specific advantages, and I for internalization.
Owner-specific advantages require that the firm have a comparative advantage in its home market that it feels it can exploit internationally. To be most effective, the advantages should be difficult to copy. Location specific advantages may be due to market imperfections or genuine comparative advantages such as a source of a particularly high quality natural resource. With internalization the firm has in its possession some proprietary information or product such as software or personnel that may provide an advantage in the international marketplace.

Question 3

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.

Answer 3

All of the above are competitive advantages.

Question 4

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.

Question 5

A strongly competitive home market tends to dull the competitive advantage relative to firms located in less competitive home markets.

Question 6

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

Question 7

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

Question 8

List and explain three strategic motives why firms could become multinationals and give an example of each.

Question 9

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.

Question 10

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.

Question 11

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

Question 12

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

Question 13

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

Question 14

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

Question 15

Reactive financial strategies can be formulated in advance by the MNE's financial managers.

Question 16

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

Question 17

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

Question 18

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.

Question 19

Proactive financial strategies depend on discovering market imperfections.

Question 20

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

Question 21

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).

Question 22

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.

Question 23

Joint ventures are a more common FDI than wholly owned subsidiaries.

Question 24

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.

Question 25

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.

Question 26

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

Question 27

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.

Question 28

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

Question 29

Licensing is a popular form of foreign investment because it does not need a sizable commitment of funds, and political risk is often minimized.

Question 30

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.

Question 31

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.

Question 32

The decision about where to invest abroad is influenced by behavioral factors. Explain the behavioral approach to FDI.

Question 33

________ 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

Question 34

Which of the following is NOT a form of FDI?

A) wholly-owned affiliate
B) joint venture
C) exporting
D) greenfield investment

Question 35

________ 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

Question 36

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.

Question 37

A ________ is a shared ownership in a foreign business.

A) licensing agreement
B) greenfield investment
C) joint venture
D) wholly-owned affiliate

Question 38

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?

Question 39

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.

Question 40

MNEs typically used licensing with independent firms rather than with their own foreign subsidiaries.

Question 41

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

Question 42

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

Question 43

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.

Question 44

________ 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

Question 45

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?

Question 46

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.

Question 47

________ is a type of political risk that OPIC does NOT cover.

A) Inconvertibility
B) Expropriation
C) War
D) OPIC covers all of the above.

Question 48

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.

Question 49

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.

Question 50

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.

Question 51

What are blocked funds? List and explain two of the three methods the authors list in this chapter for dealing with blocked funds.

Question 52

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.

Question 53

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

Question 54

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.

Question 55

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