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

A company earns most of its revenues from exporting a commodity but has costs in local currency. A risk manager wants to assess how its exposure to country risk should be estimated. Which approach most directly reflects the firm's operational exposure rather than its country of incorporation?

Weighting country risk premiums by the share of revenues or production in each country best captures operational exposure. Country risk depends on where a firm actually operates and earns income, not on its place of incorporation, so headquarters-based premiums or sovereign ratings alone misstate the exposure.

  1. AWeight the country risk premium by the share of revenues or production in each countryCorrect
  2. BApply the country risk premium of the country where the firm is headquartered
  3. CUse the sovereign rating of the country of incorporation only
  4. DIgnore country risk since the commodity is priced in global markets

Explanation

Country risk exposure follows where a firm operates, earns revenues or has production, not where it is incorporated. Weighting premiums by operations or revenue shares reflects this operational exposure. The other options rely on incorporation or ignore local costs and operations.

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