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FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications

A company based in Country Y earns 40% of revenues in Country Y (CRP 6.0%) and 60% in a mature market (CRP 0%). The mature-market premium is 4.5%. Analysts debate whether to apply the Country Y CRP to the whole company based on its country of incorporation or to weight the CRP by revenue exposure. Which statement is most consistent with exposure-based practice, and what premium results?

Weight the country risk premium by revenue exposure, giving 6.9%. Forty percent of revenues in a 6.0% CRP country yields 2.4%, which added to the 4.5% mature premium gives 6.9%. Incorporation location is not the driver of risk exposure.

  1. AWeight CRP by revenue exposure; total premium is 6.9%Correct
  2. BUse incorporation country CRP in full; total premium is 10.5%
  3. CWeight CRP by revenue exposure; total premium is 8.1%
  4. DIgnore the CRP as it is diversifiable; total premium is 4.5%

Explanation

Operating exposure drives risk, not the place of incorporation. Weighted CRP = 0.40 x 6.0% + 0.60 x 0% = 2.4%. Adding the mature premium of 4.5% gives 6.9%. The 10.5% option applies the full CRP; 8.1% wrongly weights by 60%; ignoring the CRP assumes it is fully diversifiable, which the approach rejects.

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