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

A company compares two ways to measure country risk for valuing an emerging-market business: the sovereign credit rating default spread and a composite country risk score. Which statement best describes a limitation of relying solely on the sovereign default spread?

The sovereign default spread measures the government's credit risk on its debt and may not capture how country risk affects equity investors or a specific company's operations. Firms differ in exposure by sector and revenue sources, so the spread should be adjusted rather than applied uniformly.

  1. AIt captures only the government's borrowing risk and may not reflect risk to equity or to the specific company's operationsCorrect
  2. BIt cannot be observed for any country
  3. CIt always overstates risk for private firms
  4. DIt is unaffected by market conditions

Explanation

The default spread reflects the sovereign's credit risk in its debt, while equity and firm-level exposures to the country differ by sector, export orientation and operating exposure. It is observable and varies with market conditions.

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