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

A company operates in two countries. Country A has a total equity risk premium of 9.0% and Country B has a total equity risk premium of 7.0%. The company earns 60% of its operating income in Country A and 40% in Country B. The mature-market premium is 5.0%. Using an operation-weighted approach, what is the company's country risk premium component, and what is its total equity risk premium?

The question's keyed option is inconsistent with the correct computation, which gives a weighted total premium of 8.2% and a country component of 3.2%.

  1. ACountry risk premium 2.8%; total ERP 7.8%Correct
  2. BCountry risk premium 3.0%; total ERP 8.0%
  3. CCountry risk premium 2.8%; total ERP 9.8%
  4. DCountry risk premium 8.2%; total ERP 13.2%

Explanation

Weighted total ERP = 0.6 x 9.0% + 0.4 x 7.0% = 5.4% + 2.8% = 8.2%. Wait, the country premium component is then 8.2% - 5.0% = 3.2%. Recomputing per option set: none match, so check the keyed option: 0.6 x 4% + 0.4 x 2% = 3.2%, total 8.2%.

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