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

A company in a country with a CRP of 4.0% has a beta of 1.2 relative to the mature market. The risk-free rate is 3.0% and the mature-market ERP is 5.0%. Analyst A adds the CRP directly to the cost of equity (CRP not scaled by beta). Analyst B uses the beta approach, where the CRP is multiplied by beta (cost of equity = Rf + beta x (mature ERP + CRP)). What is the difference (B minus A) in the cost of equity?

The difference is 0.8%. Analyst A gets 3% + 1.2×5% + 4% = 13.0%, while Analyst B gets 3% + 1.2×(5% + 4%) = 13.8%. The gap equals the CRP multiplied by (beta − 1), or 4% × 0.2.

  1. A0.8%Correct
  2. B0.0%
  3. C1.2%
  4. D4.8%

Explanation

A: 3.0 + 1.2x5.0 + 4.0 = 13.0%. B: 3.0 + 1.2x(5.0+4.0) = 13.8%. Difference = 0.8% (equals 0.2 x 4.0). The 4.8% option is just beta x CRP, not the difference.

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